Sales $290,000
Cost of goods sold 155,000
Gross profit $135,000
Operating expenses 207,000
Loss from operations $ (72,000)
It is estimated that 15% of the cost of goods sold represents fixed factory overhead costs and that 25% of the operating expenses are fixed. Since Star Cola is only one of many products, the fixed costs will not be materially affected if the product is discontinued.
a. Prepare a differential analysis, dated January 21, 2014, to determine whether Star Cola should be continued (Alternative 1) or discontinued (Alternative 2).
b. Should Star Cola be retained? Explain.
Answer:
a. Differential Analysis
Continue Star Cola (Alt. 1) or Discontinue Star Cola (Alt. 2)
January 21, 2014
Continue Star
Cola
(Alternative 1)
Discontinue
Star Cola
(Alternative 2)
Revenues $290,000 $ 0 –$290,000
Costs:
Variable cost of goods sold –131,7501
0
131,750
Variable operating expenses –155,250
2
0 155,250
Fixed costs –75,0003
–
75,000 0
Income (Loss) –$ 72,000 –$75,000 –$ 3,000
(1 – 15%) × $155,000
(1 – 25%) × $207,000
(15% × $155,000) + (25% × $207,000)
b. Star Cola should be retained. As indicated by the differential analysis in part
(a), the income would decrease by $3,000 if the product is discontinued.