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Horngren'S Financial And Managerial Accounting
Found in: Page 1420

Short Answer

Members of the board of directors of Security Team have received the following operating income data for the year ended March 31, 2018:

SECURITY CHECK

Income Statement

For the Year Ended May 31, 2018

Product Line

Industrial Systems

Household Systems

Total

Net Sales Revenue

$ 300,000

$ 330,000

$ 630,000

Cost of Goods Sold:

Variable

35,000

42,000

77,000

Fixed

210,000

63,000

273,000

Total Cost of Goods Sold

245,000

105,000

350,000

Gross Profit

55,000

225,000

280,000

Selling and Administrative Expenses:

Variable

66,000

77,000

143,000

Fixed

39,000

28,000

67,000

Total Selling and Administrative Expenses

105,000

105,000

210,000

Operating Income (Loss)

$ (50,000)

$ 120,000

$ 70,000

Members of the board are surprised that the industrial systems product line is losing money. They commission a study to determine whether the company should drop the line. Company accountants estimate that dropping industrial systems will decrease fixed cost of goods sold by $81,000 and decrease fixed selling and administrative expenses by $15,000.

Requirements

1. Prepare a differential analysis to show whether Security Team should drop the industrial systems product line.

2. Prepare contribution margin income statements to show Security Team’s total operating income under the two alternatives: (a) with the industrial systems line and (b) without the line. Compare the difference between the two alternatives’ income numbers to your answer to Requirement 1.

3. What have you learned from this comparison in Requirement 2?

The company should not drop the industrial systems product line.

See the step by step solution

Step by Step Solution

Step 1: Meaning of Income Statement

An income statement refers to the report presenting a business concern’s revenues and expenses in tabular format. Such a report is prepared annually to determine the profits earned or losses incurred during a particular period.

Step 2: Preparation of differential analysis

Particulars

Amounts ($)

Expected decline in revenues

(300,000)

Add: Expected decline in expenses

Variable cost of goods sold

35,000

Variable selling and administrative expenses

66,000

Decrease in fixed expenses

96,000

Expected decline in operating income

$103,000

Comment:

As per the above analysis, the company should not drop the industrial systems product line because it will lead to a decrease in operating income.

Step 3: Preparation of income statement

Contribution Margin Income Statement

Particulars

With industrial system ($)

Without industrial system ($)

Difference ($)

Net sales revenue

630,000

330,000

300,000

Less: Variable costs

Cost of goods sold

(77,000)

(42,000)

(35,000)

Selling & administrative expense

(143,000)

(77,000)

(66,000)

Contribution margin

410,000

211,000

199,000

Less: Fixed costs

Cost of goods sold

(273,000)

(192,000)

(81,000)

Selling & administrative expense

(67,000)

(52,000)

(15,000)

Operating income/(loss)

$70,000

$(33,000)

$103,000

Step 4: Learning from the comparison

According to the above-presented contribution margin income statement, it can be concluded that the company should not drop the industrial systems product line because it decreases the total operating income of the company by $103,000.

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