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Dropping or Retaining a Tour A study has indicated that some of the bus tours operated by Clear...

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Dropping or Retaining a Tour

A study has indicated that some of the bus tours operated by Clear Water Tours Inc. are not profitable. As a result, consideration is being given to dropping these unprofitable tours to improve the company's overall operating performance.

One such tour is a three-day Majestic Islands bus tour. Additional information and an income statement from a typical Majestic Islands tour are given below.

The following additional information is available about the tour:

Bus drivers are paid fixed annual salaries; tour guides are paid for each tour conducted.

The "Bus maintenance and preparation" cost in the statement is an allocation of the salaries of mechanics and other service personnel who are responsible for keeping the company's fleet of buses in good operating condition.

Ticket revenue (100 seat capacity X 40% occupancy X $70 ticket price per person) $2,800 100%
Variable expenses ($21.00 per person) 840 30
Contribution margin 1,960 70%

Tour expenses:

Tour promotion 540

Salary of bus driver 320

Fee, tour guide 630

Fuel for bus 110

Depreciation of bus 410

Liability insurance, bus 180

Overnight parking fees, bus 50

Room and meals, bus driver and tour guide 160

Bus maintenance and preparation 270

Total tour expenses 2,670

Operating loss $(710)

Depreciation of buses is due to obsolescence.

Liability insurance premiums are based on the number of buses in the company's fleet.

Dropping the Majestic Islands bus tour would not allow Clear Water Tours to reduce the number of buses in its fleet, the number of bus drivers on the payroll, or the size of the maintenance and preparation staff.

Required:

Prepare an analysis showing what the impact will be on the company's profits if this tour is discontinued.

The company's tour director has been criticized because only about 50% of the seats on Clear Water's tours are being filled, compared to an industry average of 60%. The tour director has explained that Clear Water's average seat occupancy could be improved considerably by eliminating about 10% of its tours, but that doing so would reduce profits. Explain how this could happen.

Dropping a Product or a Service:

Care should be taken when calculating the financial impact that eliminating a product or a service might have because if irrelevant costs (that are costs that cannot be avoided) are included in the calculation, the calculated financial impact will be misleading.

Answer and Explanation:


Loss in tour contribution margin $(1,960)
Saving in avoidable tour expenses
Tour promotion $540
Salary of bus driver
unavoidable so irrelevant
0
Fee, tour guide 630
Fuel for bus 110
Depreciation of bus
unavoidable so irrelevant
0
Liability insurance, bus
unavoidable so irrelevant
0
Overnight parking fee, bus 50
Room and meals, bus driver and tour guide 160
Bus maintenance and preparation
unavoidable so irrelevant
0
Decrease in operating income if the tour is dropped $(470)


Eliminating 10% of the tours will leave customers with fewer options so it is very likely that the seat occupancy of the remaining tours will increase, but it is also possible that some customers move to another tour company. However, as we habe seen above, it the elimination of the tours does not make it possible for the company to reduce the buses or the fixed salary cost, the loss in contribution margin from the discontinued tours is likely to be more than the avoidable fixed costs plus the increase in revenue on other tours.


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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