Calvert Company has 3 divisions: A, B, and C. Division A's income statement shows the following for the year ended December 31: Cost of goods sold is 80 percent variable and 20 percent fixed. Of the fixed costs, 50 percent are avoidable if the division is closed. All of the selling expenses relate to the division and would be eliminated if Division A were eliminated. Of the administrative expenses, 85 percent are applied from corporate costs. If Division A were eliminated, Calvert's income would
A) increase by $100,000.
B) decrease by $197,500.
C) decrease by $310,000.
D) decrease by $422,500.

Question

Calvert Company has 3 divisions: A, B, and C. Division A's income statement shows the following for the year ended December 31:  Cost of goods sold is 80 percent variable and 20 percent fixed. Of the fixed costs, 50 percent are avoidable if the division is closed. All of the selling expenses relate to the division and would be eliminated if Division A were eliminated. Of the administrative expenses, 85 percent are applied from corporate costs. If Division A were eliminated, Calvert's income would
A) increase by $100,000. 
B) decrease by $197,500. 
C) decrease by $310,000. 
D) decrease by $422,500.

Quizplus · Accepted Answer

If Division A is eliminated, the following costs would no longer be incurred:
- Cost of goods sold: 80% of this cost is variable, meaning it would no longer be incurred if the division is closed. The remaining 20% is fixed, but only 50% of it is avoidable. Therefore, the avoidable portion of fixed costs related to cost of goods sold is 20% * 50% = 10% of total cost of goods sold.
- Selling expenses: All of this cost relates to Division A and would be eliminated if the division is closed.
- Administrative expenses: 85% of this cost is applied from corporate costs, so only 15% of it is directly related to Division A.

Therefore, the total cost savings from eliminating Division A would be:

Total cost savings = (80% variable cost of goods sold) + (10% avoidable fixed cost of goods sold) + (selling expenses) + (15% administrative expenses)
Total cost savings = 80% + 10% + $250,000 + $275,000
Total cost savings = $807,500

However, we also need to consider the impact on revenue. Division A's revenue is $2,000,000, and if eliminated, this revenue would also be lost. Therefore, Calvert's income would decrease by the lost revenue minus the cost savings from eliminating Division A:

Income decrease = (lost revenue) - (total cost savings)
Income decrease = $2,000,000 - $807,500
Income decrease = $1,192,500

Therefore, Calvert's income would decrease by $1,192,500 if Division A were eliminated, which is answer choice C.

Calvert Company Has 3 Divisions: A, B, and C