On the basis of the following data, the general manager of Featherweight Shoes Inc. decided to discontinue Children’s Shoes because it reduced income from operations by $17,000. What is the flaw in this decision, if it is assumed fixed costs would not be materially affected by the discontinuance?
Featherweight Shoes Inc.
Product-Line Income Statement
For the Year Ended April 30, 2014
Children’s Shoes Men’s Shoes Women’s Shoes Total
Sales$235,000 $300,000 $500,000 $1,035,000
Costs of goods sold:
Variable costs$130,000 $150,000 $220,000 $ 500,000
Fixed costs 41,000 60,000 120,000 221,000
Total cost of goods sold $171,000 $210,000 $340,000 $ 721,000
Gross profit$ 64,000 $ 90,000 $160,000 $ 314,000
Selling and adminstrative expenses:
Variable selling and admin. expenses $ 46,000 $ 45,000 $ 95,000 $ 186,000
Fixed selling and admin. expenses 35,000 20,000 25,000 80,000
Total selling and admin. expenses $ 81,000 $ 65,000 $120,000 $ 266,000
Income (loss) from operations $ (17,000) $ 25,000 $ 40,000 $ 48,000
Answer:
The flaw in the decision is the failure to focus on the differential revenues and costs, which indicate that operating income would be reduced by $59,000 if Children’s Shoes were discontinued. This differential income from sales of Children’s Shoes can be determined from the following differential analysis:
Differential Analysis
Continue Children’s Shoes (Alt. 1) or Discontinue Children’s Shoes (Alt. 2)
Continue
Children’s
Shoes
(Alternative 1)
Revenues $235,000 $ 0 –$235,000
Costs:
Variable cost of goods sold –130,000 0 130,000
Variable selling and admin. expenses –46,000 0 46,000
Fixed costs –76,000* –76,000 0
Income (Loss) –$ 17,000 –$76,000 –$ 59,000
*
$41,000 + $35,000