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Cost Accounting Barbour Corporation, located in Buffalo, New York, is a retailer of high-tech...

Question:

Cost Accounting

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 has 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 $200,000 $260,000
Variable cost of goods sold 70,000 130,000
Manufacturing contribution margin $130,000 $130,000
Other expenses:
Fixed corporate costs 60,000 75,000
Variable selling and administration 20,000 50,000
Fixed selling and administration 12,000 21,000
Total other expenses $92,000 $146,000
Operating income $38,000 $(16,000)

Required:

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

2) By what percentage would sales from T-1 have to increase in order to make up the financial loss from dropping T-2? (Enter your answer as a percentage rounded to 2 decimal places (i.e. 0.1234 should be entered as 12.34).)

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 $45,000? (Enter your answer as a percentage rounded to 2 decimal places (i.e. 0.1234 should be entered as 12.34).)

Relevant Costs in Eliminating a Product or Segment:

For a cost item to be included in the financial calculations made to compute the effect that dropping a product will have, it must be avoidable if the product is discontinued. Fixed costs are often allocated to products and are seldom totally avoidable.

Answer and Explanation:


1)

The effect on the profit will be:

Loss in T-2 manufacturing contribution margin $(130,000)
Increase in T-1 manufacturing contribution margin $13,000
($130,000 x 0.10)
Saving in variable selling and administrative cost $50,000
Increase in T-1 variable selling and administrative cost $(2,000)
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 $69,000


2) Sales would from T-1 have to increase by an amount high enough to compensate for the loss of $80,000 contribution margin from T-2:

T-1 manufacturing contribution margin $130,000
Variable selling and administration 20,000
Contribution margin T-1 $110,000
Sales revenue T-1 $200,000
Contribution margin ratio 55%
Increase in sales that will yield $80,000 in contribution margin $145,455


3) T-1 sales must now generate $80,000 - $45,000 = $35,000 in additional contribution margin:

Contribution margin T-1 $110,000
Sales revenue T-1 $200,000
Contribution margin ratio 55%
Increase in sales that will yield 35,000 in contribution margin $63,637



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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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