Q25-16RQ - Horngren'S Financial And Managerial Accounting

Question

What questions should managers answer when considering dropping a product or segment?

Step-by-Step Solution

Answer

Answer

When considering dropping a product or segment, managers must answer some major questions, such as the impact of dropping the overall contribution and avoidable fixed costs factors associated with such segment or product. 

Step-by-Step Solution Step 1: Meaning of Contribution

Contribution refers to the profit left in the hands of a business entity after recovering all its variable costs from the sales revenue. It is computed by taking the difference between selling price per unit and variable cost per unit.

Step 2: Factors to be answered when dropping a product or segment

Manager must answer the following questions when dropping a product or a segment:

• First of all, managers must answer whether dropping a segment or product will result in an improved contribution.

It is the responsibility of managers to consider the factors associated with the contribution margin before dropping a product or segment. If the product has a negative contribution, it shows that the same will not be able to cover its variable costs, which will result in decreased overall contribution and vice-versa.

• Managers should verify whether such a product or segment has any avoidable fixed cost.

If there is any avoidable fixed cost, then dropping a segment or product generally improves the company's net income. This is one reason why managers must consider avoidable fixed costs before dropping a product or segment.