Granfield Company is considering eliminating its backpack division,which reported an operating loss for the recent year of $42,000.The division sales for the year were $960,000 and the variable costs were $475,000.The fixed costs of the division were $527,000.If the backpack division is dropped,40% of the fixed costs allocated to that division could be eliminated.The impact on Granfield's operating income for eliminating this business segment would be:
A)$485,000 decrease
B)$210,800 increase
C)$274,200 decrease
D)$485,000 increase
E)$274,200 increase

Question

Quizplus · Accepted Answer

First, we need to calculate the contribution margin of the backpack division:

Contribution margin = Sales − Variable costs
Contribution margin = $960,000 − $475,000
Contribution margin = $485,000

Since the backpack division reported an operating loss of $42,000, we know that its total expenses (fixed costs + variable costs) were greater than its total sales:

Total expenses = $960,000 + $42,000 = $1,002,000

Therefore, the total fixed costs of the backpack division were:

Total fixed costs = Total expenses − Total variable costs
Total fixed costs = $1,002,000 − $475,000
Total fixed costs = $527,000

If 40% of the fixed costs allocated to the backpack division could be eliminated, that means we can reduce fixed costs by:

Fixed cost savings = 40% × $527,000
Fixed cost savings = $210,800

Now we can calculate the impact of dropping the backpack division on Granfield's operating income:

Impact on operating income = (Contribution margin − Fixed costs) ± Fixed cost savings
Impact on operating income = ($485,000 − $527,000) ± $210,800
Impact on operating income = -$42,000 ± $210,800

Since we are dropping the backpack division, we should subtract the positive fixed cost savings from the negative impact of losing the contribution margin and fixed costs:

Impact on operating income = -$42,000 − $210,800
Impact on operating income = -$252,800

Therefore, the answer is C) $274,200 decrease. Note that this is the opposite sign of the impact on operating income, because we are looking for the change in income, not the final income.

Granfield Company Is Considering Eliminating Its Backpack Division,which Reported an Operating