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Horngren'S Financial And Managerial Accounting
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Short Answer

McCollum Company manufactures two products. Both products have the same sales price, and the volume of sales is equivalent. However, due to the difference in production processes, Product A has higher variable costs and Product B has higher fixed costs. Management is considering dropping Product B because that product line has an operating loss.

MCCOLLUM COMPANY

Income Statement

Month Ended June 30, 2018

Total Product A Product B

Net Sales Revenue $150,000 $75,000 $75,000

Variable Costs 90,000 55,000 35,000

Contribution Margin 60,000 20,000 40,000

Fixed Costs 50,000 5,000 45,000

Operating Income/(Loss) $10,000 $15,000 $(5,000)

  1. If fixed costs cannot be avoided, should McCollum drop Product B? Why or why not?
  2. If 50% of Product B’s fixed costs are avoidable, should McCollum drop Product B? Why or why not?

  1. Yes, the company should drop product B because it is incurring losses to the company.
  2. The product should be kept if fixed costs are avoidable.
See the step by step solution

Step by Step Solution

Meaning of Operating Income

Operating income refers to the amount of money left with a business entity after the settlement of all the variable and fixed costs associated with a product's sales process. Operating income includes the core operations of an entity.

Decision of dropping the product

The company should drop product B because it incurs losses to the company and decreases the overall operating income of the product line. Hence, the product should be dropped if fixed costs cannot be avoided.

Decision taken in case fixed cost can be avoided

Particulars

Amount ($)

Net sales revenue

75,000

Less: Variable costs

(35,000)

Contribution margin

40,000

Less: Fixed costs (45,000*50%)

(22,500)

Operating income

$17,500

The company should keep product B in its product line if the fixed costs associated with the same are 50% avoidable. This will generate revenues for the company and result in an overall increase in the product line’s operating income.

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Snappy Plants operates a commercial plant nursery where it propagates plants for garden centers throughout the region. Snappy Plants has $5,100,000 in assets. Its yearly fixed costs are $650,000, and the variable costs for the potting soil, container, label, seedling, and labor for each gallon-size plant total $1.90. Snappy Plants’s volume is currently 500,000 units. Competitors offer the same plants, at the same quality, to garden centers for $4.25 each. Garden centers then mark them up to sell to the public for $9 to $12, depending on the type of plant.

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