Question
Abba, Inc. is considering dropping a product line. During the prior year, the line had sales of $207,000 and a contribution margin of $124,000. Fixed expenses consist of:
Salaries
$60,000
Rent
50,000
Advertising
20,000
Administrative
35,000
Total fixed expenses
$165,000
The product line manager's $60,000 salary is avoidable as is the $20,000 of advertising. Of the administrative expenses, $10,000 is avoidable. The rest are general allocated expenses that will not change if the product is dropped. The rent expense is allocated to product lines based on sales and represents a share of the total cost for the building. If this product line is dropped, overall net operating income will Blank______.
Multiple choice question.
decrease by $124,000
decrease by $34,000
increase by $41,000
increase by $16,000
Salaries
$60,000
Rent
50,000
Advertising
20,000
Administrative
35,000
Total fixed expenses
$165,000
The product line manager's $60,000 salary is avoidable as is the $20,000 of advertising. Of the administrative expenses, $10,000 is avoidable. The rest are general allocated expenses that will not change if the product is dropped. The rent expense is allocated to product lines based on sales and represents a share of the total cost for the building. If this product line is dropped, overall net operating income will Blank______.
Multiple choice question.
decrease by $124,000
decrease by $34,000
increase by $41,000
increase by $16,000
Answers
GPT-4o mini
To determine the effect on overall net operating income if Abba, Inc. drops the product line, we need to analyze the contribution margin, fixed expenses, and which costs are avoidable.
1. **Contribution Margin from the Product Line:**
- Contribution Margin = $124,000
2. **Avoidable Fixed Expenses if the Product Line is Dropped:**
- Salaries: $60,000 (avoidable)
- Advertising: $20,000 (avoidable)
- Administrative: $10,000 (avoidable out of $35,000 total)
The rent expense ($50,000) and the remaining $25,000 of administrative expenses are not avoidable because they won't change if the product line is dropped.
3. **Total Avoidable Expenses:**
- Total avoidable fixed expenses = $60,000 (salaries) + $20,000 (advertising) + $10,000 (administrative)
- Total avoidable fixed expenses = $90,000
4. **Net Effect on Operating Income:**
- If the product line is dropped, the contribution margin of $124,000 will be lost.
- However, by dropping the line, $90,000 in avoidable fixed expenses will also be eliminated.
5. **Calculation of Change in Net Operating Income:**
- Change in Net Operating Income = Loss of Contribution Margin - Avoidable Fixed Expenses
- Change in Net Operating Income = $124,000 - $90,000
- Change in Net Operating Income = $34,000
Since the company would lose $34,000 more than it saves in avoidable expenses, the overall net operating income will **decrease by $34,000** if the product line is dropped.
Therefore, the correct answer is:
**decrease by $34,000**.
1. **Contribution Margin from the Product Line:**
- Contribution Margin = $124,000
2. **Avoidable Fixed Expenses if the Product Line is Dropped:**
- Salaries: $60,000 (avoidable)
- Advertising: $20,000 (avoidable)
- Administrative: $10,000 (avoidable out of $35,000 total)
The rent expense ($50,000) and the remaining $25,000 of administrative expenses are not avoidable because they won't change if the product line is dropped.
3. **Total Avoidable Expenses:**
- Total avoidable fixed expenses = $60,000 (salaries) + $20,000 (advertising) + $10,000 (administrative)
- Total avoidable fixed expenses = $90,000
4. **Net Effect on Operating Income:**
- If the product line is dropped, the contribution margin of $124,000 will be lost.
- However, by dropping the line, $90,000 in avoidable fixed expenses will also be eliminated.
5. **Calculation of Change in Net Operating Income:**
- Change in Net Operating Income = Loss of Contribution Margin - Avoidable Fixed Expenses
- Change in Net Operating Income = $124,000 - $90,000
- Change in Net Operating Income = $34,000
Since the company would lose $34,000 more than it saves in avoidable expenses, the overall net operating income will **decrease by $34,000** if the product line is dropped.
Therefore, the correct answer is:
**decrease by $34,000**.