Marshal Costumes owns two stores and management is considering eliminating the Mandarin store due to declining sales.Common fixed costs are allocated on the basis of sales.Contribution income statements are as follows: $\begin{array}{lrrr}&\text { Arlington }&\text {Mandarin}&\text { Total }\
\text { Sales } & \$ 300,000 & \$ 200,000 & \$ 500,000 \
\text { Variable costs } & 160,000 & 130,000 & 290,000 \
\text { Direct fixed costs } & 40,000 & 20,000 & 60,000 \
\text { Allocated fixed costs } & 80,000 & 65,000 & 145,000 \
\text { Net Income } & \$ 20,000 & \$(15,000) & \$ 5,000
\end{array}$ Marshal's management feels that if they eliminate the Mandarin store, that sales in the Arlington store will increase by 10%.If the Mandarin store is closed, what is the incremental effect on profit for Marshal Costumes?
A)Increase by $17,000
B)Decrease by $36,000
C)Increase by $22,000
D)Decrease by $20,000

Question

Quizplus · Accepted Answer

If the Mandarin store is closed, its sales will not contribute to covering the common fixed costs, which are currently allocated based on sales. The elimination of the Mandarin store's sales means that its portion of the common fixed costs (allocated fixed costs of $65,000) would need to be absorbed by the Arlington store or eliminated if not strictly tied to the operation of the Mandarin store. However, the question does not specify that these costs can be eliminated, so we assume they must be absorbed by the company. The Mandarin store's direct contribution margin (sales minus variable costs) is $70,000 ($200,000 - $130,000). If the store is closed, this amount will no longer contribute to covering fixed costs. The increase in sales at the Arlington store (10% of $300,000 = $30,000) will bring additional contribution margin, but this must be adjusted for variable costs. Assuming the variable cost ratio for Arlington remains constant (160,000/300,000 = 53.33%), the additional variable costs for the increased sales would be $16,000 (approximately 53.33% of $30,000). Thus, the net additional contribution from increased sales at Arlington would be $14,000 ($30,000 - $16,000). Therefore, the net effect of closing the Mandarin store would be a decrease in overall profit, calculated as the loss of the Mandarin store's contribution margin minus the net gain from increased Arlington sales: $70,000 (lost contribution margin) - $14,000 (net gain from Arlington) = $56,000 decrease in contribution margin. Since the question asks for the incremental effect on profit, and given that the Mandarin store is currently showing a net loss of $15,000, the overall decrease in profit would be less than the decrease in contribution margin. However, without specific details on how the allocated fixed costs would be managed or potentially reduced, the closest answer reflecting a decrease in profit due to the closure of the Mandarin store and considering the partial offset by increased sales at Arlington is a decrease by $36,000, acknowledging that the exact figure might involve more detailed calculations of fixed cost allocations and their impact.

Marshal Costumes Owns Two Stores and Management Is Considering Eliminating