CMA Study Group

Hi, I am currently studying to hopefully take Part 1 in September and need a bit of help with the following question, the answer is B but there is no explanation.


A company has two business units (Division 1 and Division 2) that are currently operating as
profit centers. Management is evaluating the possibility of discontinuing Division 2 because of
the operating losses it has experienced over the last few years. Select information from the
operating budget for the upcoming fiscal year is shown below.

                                                                                   Division 1            Division 2
Sales                                                                         $800,000             $400,000
Cost of goods sold                                                      300,000               250,000
Gross margin                                                              500,000               150,000
Variable selling and administrative expenses             100,000                 80,000
Fixed selling and administrative expenses                   75,000                 75,000
Operating income (loss)                                            $325,000               ($5,000)

Fixed selling and administrative expenses are allocated equally between the two units. If
Division 2 is discontinued, fixed selling and administrative expenses are expected to decrease
by 20% from the current level, and Division 1's sales are expected to increase by 15%. Based
on the budget information above, should the company discontinue Division 2, and why?

a. Yes, because operating income will increase by $80,000.
b. Yes, because operating income will increase by $20,000.
c. No, because operating income will decrease by $40,000.
d. No, because operating income will decrease by $10,000.

------------------------------
Carla Loera
Student
Laredo TX
United States
------------------------------

Hello Carla,

The key point you may have missed while solving this question is: Variable cost will increase based on sales volume increase
We should apply this concept on both of COGS and variable selling & admin expenses. (Incremental costs)

Here are the solution steps:

Division's (1) increased sales = $800,000 x (1 + 15%) = $920,000
 
Division's (1) COGS % = $300,000 / $800,000 = 37.5% 
Division's (1) increased COGS = $920,000 X 37.5% = $345,000
 
Division's (1) variable selling & Admin expenses % = $100,000 / $800,000 = 12.5% 
Division's (1) increased variable selling & Admin expenses = $920,000 X 12.5% = $115,000
 
Each division remaining fixed Selling & Admin expenses = $75,000 x 80% = $60,000 (Irrelevant / Sunk cost)
 
Net impact of discontinuing Division (2) = $920,000 - $345,000 - $115,000 - $120,000
                                                                       = $20,000  >>>  Discontinue Division (2)  >>>  Answer (B) is correct

Gentle reminder:
Please, pay a very close attention to Variable Cost & Contribution margin concepts, because you will be using them a lot in Marginal Analysis (Part 2)

Hope this illustration will be helpful to you and every concerned member.

Kind regards



------------------------------
Samer Ahmad, FMVA, SCA
Kuwait
------------------------------

Original Message:
Sent: 06-18-2020 11:54 AM
From: Carla Loera
Subject: Exam 1 Additional Practice Question

Hi, I am currently studying to hopefully take Part 1 in September and need a bit of help with the following question, the answer is B but there is no explanation.


A company has two business units (Division 1 and Division 2) that are currently operating as
profit centers. Management is evaluating the possibility of discontinuing Division 2 because of
the operating losses it has experienced over the last few years. Select information from the
operating budget for the upcoming fiscal year is shown below.

                                                                                   Division 1            Division 2
Sales                                                                         $800,000             $400,000
Cost of goods sold                                                      300,000               250,000
Gross margin                                                              500,000               150,000
Variable selling and administrative expenses             100,000                 80,000
Fixed selling and administrative expenses                   75,000                 75,000
Operating income (loss)                                            $325,000               ($5,000)

Fixed selling and administrative expenses are allocated equally between the two units. If
Division 2 is discontinued, fixed selling and administrative expenses are expected to decrease
by 20% from the current level, and Division 1's sales are expected to increase by 15%. Based
on the budget information above, should the company discontinue Division 2, and why?

a. Yes, because operating income will increase by $80,000.
b. Yes, because operating income will increase by $20,000.
c. No, because operating income will decrease by $40,000.
d. No, because operating income will decrease by $10,000.

------------------------------
Carla Loera
Student
Laredo TX
United States
------------------------------

thank you so much for your help!

------------------------------
Carla Loera
Student
Laredo TX
United States
------------------------------

Original Message:
Sent: 06-18-2020 04:23 PM
From: Samer Ahmad
Subject: Exam 1 Additional Practice Question

Hello Carla,

The key point you may have missed while solving this question is: Variable cost will increase based on sales volume increase
We should apply this concept on both of COGS and variable selling & admin expenses. (Incremental costs)

Here are the solution steps:

Division's (1) increased sales = $800,000 x (1 + 15%) = $920,000
 
Division's (1) COGS % = $300,000 / $800,000 = 37.5%
Division's (1) increased COGS = $920,000 X 37.5% = $345,000
 
Division's (1) variable selling & Admin expenses % = $100,000 / $800,000 = 12.5%
Division's (1) increased variable selling & Admin expenses = $920,000 X 12.5% = $115,000
 
Each division remaining fixed Selling & Admin expenses = $75,000 x 80% = $60,000 (Irrelevant / Sunk cost)
 
Net impact of discontinuing Division (2) = $920,000 - $345,000 - $115,000 - $120,000
                                                                       = $20,000  >>>  Discontinue Division (2)  >>>  Answer (B) is correct

Gentle reminder:
Please, pay a very close attention to Variable Cost & Contribution margin concepts, because you will be using them a lot in Marginal Analysis (Part 2)

Hope this illustration will be helpful to you and every concerned member.

Kind regards

------------------------------
Samer Ahmad, FMVA, SCA
Kuwait

Original Message:
Sent: 06-18-2020 11:54 AM
From: Carla Loera
Subject: Exam 1 Additional Practice Question

Hi, I am currently studying to hopefully take Part 1 in September and need a bit of help with the following question, the answer is B but there is no explanation.


A company has two business units (Division 1 and Division 2) that are currently operating as
profit centers. Management is evaluating the possibility of discontinuing Division 2 because of
the operating losses it has experienced over the last few years. Select information from the
operating budget for the upcoming fiscal year is shown below.

                                                                                   Division 1            Division 2
Sales                                                                         $800,000             $400,000
Cost of goods sold                                                      300,000               250,000
Gross margin                                                              500,000               150,000
Variable selling and administrative expenses             100,000                 80,000
Fixed selling and administrative expenses                   75,000                 75,000
Operating income (loss)                                            $325,000               ($5,000)

Fixed selling and administrative expenses are allocated equally between the two units. If
Division 2 is discontinued, fixed selling and administrative expenses are expected to decrease
by 20% from the current level, and Division 1's sales are expected to increase by 15%. Based
on the budget information above, should the company discontinue Division 2, and why?

a. Yes, because operating income will increase by $80,000.
b. Yes, because operating income will increase by $20,000.
c. No, because operating income will decrease by $40,000.
d. No, because operating income will decrease by $10,000.

------------------------------
Carla Loera
Student
Laredo TX
United States
------------------------------