Question

Beautiful Watches has two product lines: Luxury watches and Sporty watches. Income statement data for the most recent year follow: ...................................................Total........................Luxury.........................Sporty Sales revenue..........................$490,000.................$360,000.....................$130,000 Variable expenses.....................359,000...................235,000.......................124,000 Contribution margin.................131,000...................125,000............................6000 Fixed expenses............................76,000.....................38,000..........................38,000 Operating income (loss)...........$55,000...................$87,000.......................-$32,000 Assuming fixed costs remain unchanged, how would discontinuing the Sporty line affect operating income?

A) Decrease in total operating income of $6000

B) Decrease in total operating income of $131,000

C) Increase in total operating income of $49,000

D) Increase in total operating income of $130,000

Answer 1

Answer-

The correct Option is A. Decrease in total operating income of $6000.

The discontinuing the Sporty line will forego the revenues generated by the business of Sporty line, but the company (Beautifiul watches) has to bear the cost of Fixed expenses of $ 38000 incurred by Spoty watches. However the Sporty watches would have incurred a loss of $ 32000 if continued production. The company has to bear the Fixed expenses irrespective of whether the company continues or discontinues the Sporty line business.  

Therefore the Total operating income would have been

= Total operating expenses -  ( $ 38000 - $ 32000)  
= $ 55000 - ( $ 38000 - $ 32000)
= $ 55000 - $ 6000
= $ 49000

Therefore there is a decrease of $ 6000 ( $ 55000 - $ 49000) in Operating income.

The other options B,C and D are incorrect.