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Bed & Bath, a retailing company, has two departments—Hardware and Linens. The company’s most recent monthly contribution format income statement follows: Department Total Hardware Linens Sales $ 4,190,000 $ 3,180,000 $ 1,010,000 Variable expenses 1,242,000 841,000 401,000 Contribution margin 2,948,000 2,339,000 609,000 Fixed expenses 2,270,000 1,420,000 850,000 Net operating income (loss) $ 678,000 $ 919,000 $ (241,000 ) A study indicates that $379,000 of the fixed expenses being charged to Linens are sunk costs or allocated costs that will continue even if the Linens Department is dropped. In addition, the elimination of the Linens Department will result in a 18% decrease in the sales of the Hardware Department. Required: What is the financial advantage (disadvantage) of discontinuing the Linens Department?

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Answer:

The financial advantage of discontinuing the Linens Department is $359,980

Explanation:

If Linens Department is discontinued, there is only Hardware Department left. The new sales, costs and operating income will be:

Sales = 3,180,000 x (1 -18%) = $2,607,600 ( 18% drop in sales of Hardware given Linens discontinuity)

Variable cost = 2,607,600 x ( 841,000 / 3,180,000) = $689,620.

Fixed cost = Fixed cost originally allocated to Hardware + Fixed cost further allocated to Hardware due to Linen's discontinuity = 1,420,000 + 379,000 = $1,799,000.

Operating income = 2,607,600 - 689,620 - 1,799,000 = $118,980.

=> Difference between discontinuity of Linen Department and continuity of Linen Department = 118,980 - (-241,000) = $359,980.

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