3TI
Question
McCollum Company manufactures two products. Both products have the same sales price, and the volume of sales is equivalent. However, due to the difference in production processes, Product A has higher variable costs and Product B has higher fixed costs. Management is considering dropping Product B because that product line has an operating loss.
MCCOLLUM COMPANY
Income Statement
Month Ended June 30, 2018
Total Product A Product B
Net Sales Revenue \(150,000 \)75,000 \(75,000
Variable Costs 90,000 55,000 35,000
Contribution Margin 60,000 20,000 40,000
Fixed Costs 50,000 5,000 45,000
Operating Income/(Loss) \)10,000 \(15,000 \)(5,000)
- If fixed costs cannot be avoided, should McCollum drop Product B? Why or why not?
- If 50% of Product B’s fixed costs are avoidable, should McCollum drop Product B? Why or why not?
Step-by-Step Solution
Verified- Yes, the company should drop product B because it is incurring losses to the company.
- The product should be kept if fixed costs are avoidable.
Operating income refers to the amount of money left with a business entity after the settlement of all the variable and fixed costs associated with a product's sales process. Operating income includes the core operations of an entity.
The company should drop product B because it incurs losses to the company and decreases the overall operating income of the product line. Hence, the product should be dropped if fixed costs cannot be avoided.
Particulars | Amount ($) |
Net sales revenue | 75,000 |
Less: Variable costs | (35,000) |
Contribution margin | 40,000 |
Less: Fixed costs (45,000*50%) | (22,500) |
Operating income | $17,500 |
The company should keep product B in its product line if the fixed costs associated with the same are 50% avoidable. This will generate revenues for the company and result in an overall increase in the product line’s operating income.