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Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094

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BuyFindarrow_forward

Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094
Textbook Problem

Decision to discontinue a product

On the basis of the following data, the general manager of Foremost Footwear Inc. decided to discontinue Children’s Shoes because it reduced income from operations by $10,000. What is the flaw in this decision if it is assumed that fixed costs would not be materially affected by the discontinuance?

Foremost Footwear Inc. Product-Line Income Statement For the Year Ended April 30, 20Y7
  Children’s Shoes Men’s Shoes Women’s Shoes Total
Sales $165,000 $300,000 $500,000 $965,000
Costs of goods sold:
Variable costs $105,000 $150,000 $220,000 $475,000
Fixed costs 32,000 60,000 120,000 212,000
Total cost of goods sold $137,000 $210,000 $340,000 $687,000
Gross profit $ 28,000 $ 90,000 $160,000 $278,000
Selling and administrative expenses:
Variable selling and admin, expenses $ 21,000 $ 45,000 $ 95,000 $161,000
Fixed selling and admin, expenses 17,000 20,000 25,000 62,000
Total selling and admin, expenses $ 38,000 $ 65,000 $120,000 $223,000
Income {loss} from operations $ (10,000} $ 25,000 $ 40,000 $ 55,000

To determine

Differential Analysis: Differential analysis refers to the analysis of differential revenue that could be gained or differential cost that could be incurred from the available alternative options of business.

To Identify: The flaw in the decision of assuming that fixed costs would not be materially affected by discontinuation of the Children’s shoes.

Explanation

The differential analysis of Company FF as on April 30, 20Y7 is shown below.

Differential Analysis of Company FF
Continue (Alt. 1) or Discontinue (Alt. 2) Children's Shoes
April 30, 20Y7
Continue Children's Shoes  (Alternative 1) Discontinue Children's Shoes  (Alternative 2) Differential Effect on income
Revenues $165,000 $0 (-)  $165,000
Costs:
Variable costs of goods sold (-)  $105,000 $105,000
Variable selling and administrative expenses (-)  $21,000 $21,000
Fixed Costs (1)  (-)  $49,000 (-)  $49,000
Income (loss) (-)  $10,000 (-)  $49,000 (-)  $39,000

Table (1)

The differential analysis of Company FF as on April 30, 20Y7 shows that both continuing and discontinuing children’s shoes would result in operating loss. However, continuing the Children’s shoes would reduce the loss by $39,000, thus the decision by the management of the Company FF is incorrect.

The differential analysis of Company FF shows that the fixed costs are constant immaterial of what is being produced or not by the company...

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