Barbour Corporation, located in Buffalo, New York, is a retailer of high tech products and is...

Question:

Barbour Corporation, located in Buffalo, New York, is a retailer of high tech products and is known for its excellent quality and innovation. Recently the firm conducted a relevant cost analysis of one of its product lines that have only two products, T-1 and T-2. The sales for T-2 are decreasing and the purchase costs are increasing. The firm might drop T-2 and sell only T-1.

Barbour allocates fixed costs to products on the basis of sales revenue. When the president of Barbour saw the income statement, he agreed that T-2 should be dropped. If this is done, sales of T-1 are expected to increase by 10% next year, the firm's cost structure will remain the same.

T-1 T-2
Sales $220,000 $276,000
Variable cost of goods sold 74,000 138,000
Contribution margin 146,000 138,000
Expenses:
Fixed corporate costs 64,000 79,000
Variable selling and administration 25,000 54,000
Fixed selling and administration 16,000 25,000
Total expenses 105,000 158,000
Operating income (loss) $41,000 $(20,000)

Required:

1. Find the expected change in annual operating income by dropping T-2 and selling only T-1.

Net loss on discontinuing T-2

2. By what percentage would sales from T-1 have to increase in order to make up the financial loss from dropping T-2?

Required percent increase in sales of T-1

3. What is the required percentage increase in sales from T-1 to compensate for lost margin from T-2, if total fixed costs can be reduced by $45,500?

Required percent increase in sales of T-1

Dropping a Product:

The financial impact that dropping a product will have is always equal to the loss in its contribution margin minus savings in avoidable fixed costs and plus or minus the impact of any opportunity costs.

Answer and Explanation:


1)

The effect on the profit will be:

Loss in T-2 manufacturing contribution margin $(138,000)
Increase in T-1 manufacturing contribution margin $14,600
($146,000 x 0.10)
Saving in variable selling and administrative cost $54,000
Increase in T-1 variable selling and administrative cost $(2,500)
Saving in fixed costs
(fixed costs cannot be avoided and will only be reallocated if the product is dropped)
$0
Decrease in profit if T-2 is dropped $71,900


2) Sales would from T-1 have to increase by an amount high enough to compensate for the loss of $138,000 - $54,000 = $84,000 contribution margin from T-2:

T-1 manufacturing contribution margin $146,000
Variable selling and administration 25,000
Contribution margin T-1 $121,000
Sales revenue T-1 $220,000
Contribution margin ratio 55%
Increase in sales that will yield $84,000 in contribution margin $152,728


3) T-1 sales must now generate $84,000 - $45,500 = $38,500 in additional contribution margin:

Contribution margin T-1 $121,000
Sales revenue T-1 $220,000
Contribution margin ratio 55%
Increase in sales that will yield $38,500 in contribution margin $70,000



Learn more about this topic:

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Relevant Costs in Eliminating a Product or Segment

from Accounting 301: Applied Managerial Accounting

Chapter 9 / Lesson 12
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