Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 37

Profitability Analysis Barbour Corporation, located in Buffalo, New York, is a retailer of hightech products known for its excellent quality and innovation. Recently the firm conducted a relevant cost analysis of one of its product lines that has only two products, T-1 and T-2. The sales for T-2 are decreasing and the purchase costs are increasing. The firm might drop T-2 and sell only T-1.

Barbour allocates fixed costs to products on the basis of sales revenue. When the president of Barbour saw the income statement, he agreed that T-2 should be dropped. If this is done, sales of T-1 are expected to increase by 10 percent next year; the firm’s cost structure will remain the same.

	T-1	T-2
Sales	$200,000	$260,000
Variable cost of goods sold	70,000	130,000
Contribution margin	$130,000	$130,000
Expenses
Fixed corporate costs	60,000	75,000
Variable selling and administration	20,000	50,000
Fixed selling and administration	12,000	21,000
Total expenses	$ 92,000	$146,000
Operating income	$ 38,000	$ (16,000)

Required

1. Find the expected change in annual operating income by dropping T-2 and selling only T-1.

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2. What strategic factors should be considered?

Step 1 of 3

Fixed costs are costs which does not changes with change in level of production. Variable costs are costs which does changes with change in level of production.