# Gutierrez Company has four operating divisions. During the first quarter of 2014, the company...

## Question:

Gutierrez Company has four operating divisions. During the first quarter of 2014, the company reported aggregate income from operations of $213,000 and the following divisional results. Division I Division II Division III Division IV Sales revenue$250,000 $200,000$500,000 $450,000 Cost of goods sold 200,000 192,000 300,000 250,000 Selling and administrative expenses 75,000 60,000 60,000 50,000 Income (loss) from operations$(25,000) $(52,000)$140,000 $150,000 Analysis reveals the following percentages of variable costs in each division. I II III IV Cost of goods sold 75% 90% 80% 75% Selling and administrative expenses 40 70 50 60 Discontinuance of any division would save 50% of the fixed costs and expenses for that division. Top management is very concerned about the unprofitable divisions (I and II). Consensus is that one or both of the divisions should be discontinued. (a) Compute the contribution margin for Divisions I and II. (b) Prepare an incremental analysis concerning the possible discontinuance of (1) Division I and (2) Division II. What course of action do you recommend for each division? (c) Prepare a columnar condensed income statement for Gutierrez Company, assuming Division II is eliminated. (Use the CVP format.) Division II's unavoidable fixed costs are allocated equally to the continuing divisions. (d) Reconcile the total income from operations ($213,000) with the total income from operations without Division II.

## Discontinuing a Division:

Before a seemingly loss-making division is discontinued, its costs should be examined in order to determine which costs are avoidable and which costs will continue and would have to be absorbed by the other divisions. Only the avoidable costs are relevant to the decision,

(a)

Division I Division II
Sales revenue $250,000$200,000
Variable Costs
Cost of goods sold 150,000
($200,000 x 0.75) 172,800 Selling and administrative expenses 30,000 42,000 Contribution margin$70,000 ($14,800) (b) - (1) #### Division I - Incremental Analysis Continue Division I Discontinue Division I Sales revenue$250,000 0
Variable Costs
Cost of goods sold 150,000 0
Selling and administrative expenses 30,000 0
Contribution margin $70,000$0
Fixed Costs
Cost of goods sold 50,000
($200,000 -$150,000)
25,000
(50% will be avoided)
Selling and administrative expenses 45,000 22,500
Operating Income (Loss) $(25,000)$(47,500)

#### Division II - Incremental Analysis

Continue Division II Discontinue Division II
Sales revenue $200,000 0 Variable Costs Cost of goods sold 172,800 0 Selling and administrative expenses 42,000 0 Contribution margin$(14,800) $0 Fixed Costs Cost of goods sold 19,200 ($192,000 x 0.10)
9,600
(50% will be avoided)
Selling and administrative expenses 18,000 9,000
Operating Income (Loss) $(52,000)$(18,600)

Division I should be retained and division II should be discontinued.

(c)

#### Condenced Income Statement

 Division I Division II Division III Division IV Total $(31,200) Sales revenue$250,000 0 $500,000$450,000 $1,200,000 Variable cost: Cost of goods sold 150,000 240,000 ($300,000 x 0.80) 187,500 ($250,000 x 0.75) 577,500 Selling and administrative expenses 30,000 30,000 30,000 90,000 Contribution margin$70,000 $0$230,000 $232,500$532,500 Fixed Cost Cost of goods sold 53,200 ($50,000 + ($9,600 / 3)) 0 63,200 ($60,000 + (($9,600 / 3)) 65,700 196,500 Selling and administrative expenses 48,000 ($45,000 + ($9,000 / 3)) 0 33,000 23,000 119,000 Income (loss) from operations $0$143,800

(d)

$33,400$33,400 ($52,000 -$18,600) Total Net income from operations \$213,000 Net income from operations without Division II 246,400 Difference Incremental profit from discontinuing division II