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Unformatted text preview: n $ 200,000 Situation W ith New Machine $ 200,000 Sales (5,000 units @ $40 per unit) Less variable expenses: Direct materials (5,000 units @ $14 per unit) We can efficiently analyze the decision 70,000 by We can analyze 70,000 Direct labor (5,000 units @ $8 and $5 per unit) 25,000 looking at the different costs 40,000 revenues and Variable overhead (5,000 units @ $2 per unit) 10,000 10,000 a nd solution 105,000 the Total variable expenses nd arrive at the same 120,000 Contribution margin 80,000 95,000 N Less fixed expense:et Advantage to Renting the New Machine Decrease in direct labor costs (5,000 units @ $3 per unit) $ 15,000 Other 62,000 62,000 I ncrease in fixed rental expenses (3,000) Rent on new machine cost saving from renting the new machine 3,000 Net annual $ 12,000 Total fixed expenses 62,000 65,000 Net operating income $ 18,000 $ 30,000 . Differential Costs and Benefits 15,000 15,000 (3,000) (3,000) 12,000 10-15 Total and Differential Cost Approaches Using the differential cost approach is desirable for two reasons: 1. Only rarely will enough information be available to prepare detailed income statements for both alternatives. 2. Mingling irrelevant costs with relevant costs may cause confusion and distract attention away from the information that is really critical. 10-16 Learning Objective 2 Prepare an analysis showing whether a product line or other business segment should be added or dropped. 10-17 Adding/Dropping Segments One of the most important One decisions managers make is whether to add or drop a business segment. Ultimately, a decision to drop an old segment or add a new one is going to hinge primarily on the impact the decision will have on net operating income. To assess this To impact, it is necessary to carefully analyze the costs. 10-18 Adding/Dropping Segments Due to the declining popularity of digital watches, Lovell Company’s digital watch line has not reported a profit for several years. Lovell is considering discontinuing this product line. 10-19 A Contribution Margin Approach DECISION RULE DECISION Lovell should drop the digital watch segment only if its profit would increase. Lovell will compare the contribution margin that would be lost to the costs that would be avoided if the line was to be dropped. 10-20 Adding/Dropping Segments Segment Income Statement Digital Watches Sales Less: variable expenses Variable manufacturing costs Variable shipping costs Commissions Contribution margin Less: fixed expenses General factory overhead Salary of line manager Depreciation of equipment Advertising - direct Rent - factory space General admin. expenses Net operating loss $ 500,000 $ 120,000 5,000 75,000 $ 60,000 90,000 50,000 100,000 70,000 30,000 200,000 $ 300,000 400,000 $ (100,000) 10-21 Adding/Dropping Segments Segment Income Statement Digital Watches Sales $ 500,000 Less: n investigation has revealed that tthe fixed A variable expenses An investigation has revealed that he fixed An An Variable manufacturing costs a$ 120,000 general general factory overhead and ffixed general general factory overhead nd ixed general general Variable shipping costs 5,000 administrative expenses will not be affected 00,000 administrative expenses will not be affected by administrative administrative Commissions 75,000 2 by dropping the digital watch line. The fixed general Contributiont...
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This document was uploaded on 03/23/2014.

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