J.M Smucker Company operates two divisions, the Fruit Preserves Division and the Snack Foods Division. The Fruit Preserves Division manufactures and sells jelly and jams to supermarkets. The Snack Foods Division sells its products to theme parks. The company is considering disposing of the Snack Foods Division. since it has been consistently unprofitable for a number of years. The income statements for the two divisions for the year ended December 31, 2015 are presented below:
|Fruit Preserves Division||Snack Foods Division||Total|
|Cost of goods sold||900,000||350,000||1,250,000|
|Selling & admin expenses||250,000||180,000||430,000|
In the Snack Foods Division, 60% of the cost of goods sold are variable costs and 25% of selling and administrative expenses are variable costs. The management of the company feels it can save $60,000 of fixed cost of goods sold and $50,000 of fixed selling expenses if it discontinues operation of the Snack Foods Division.
(a) Determine whether the company should discontinue operating the Snack Foods Division. Prepare a schedule which supports your decision.
(b) If the company had discontinued the division for 2015, determine what net income would have been.
Companies often need to determine relevant costs and benefits when making decisions like whether to make or buy, adding or dropping a product line, or special order decisions. Make or buy decisions are outsourcing decisions where companies decide whether to produce a product themselves or to buy them from an external supplier. The decision to add or drop a product line looks at overall profitability of a firm if a particular product line is dropped. Special order decisions are one-off, short-term decisions that a company makes in deciding whether to supply goods to a customer.
All these decisions require the calculation of relevant costs. Relevant costs are future costs that differ between alternatives. Examples of relevant costs include the loss of contribution margin if a product line is dropped. If costs do not differ between alternatives, they are deemed irrelevant costs and will not be included in decision making. Examples of irrelevant costs are unavoidable fixed costs. Besides quantitative data about relevant costing, companies will also need to examine qualitative information before making decisions.
Answer and Explanation:
Variable cost of goods sold for Snack Foods Division = 350,000 x 60% = 210,000
Variable selling and admin expenses for Snack Foods Division = 180,000 x 25% = 45,000
Current contribution margin of Snack Foods Division = 500,000 - 210,000 - 45,000 = 245,500
If Snack Foods Division is closed:
|Loss of CM||(245,000)|
|Savings on fixed cost of goods sold||60,000|
|Savings on fixed selling expenses||50,000|
Based on quantitative analysis above, the company should not discontinue the Snacks Food Division, as it will result in a loss of 135,000 to the company.
Net income would have been 320,000 - 135,000 = $185,000
Learn more about this topic:
from Accounting 301: Applied Managerial AccountingChapter 9 / Lesson 12