CMA Study Group

Exam 1 Additional Practice Question

  • 1.  Exam 1 Additional Practice Question

    Posted 19 days ago
    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.

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    Carla Loera
    Student
    Laredo TX
    United States
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  • 2.  RE: Exam 1 Additional Practice Question

    Posted 18 days ago
    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

    Keep or Drop decision analysis


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    Samer Ahmad, FMVA, SCA
    Kuwait
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  • 3.  RE: Exam 1 Additional Practice Question

    Posted 18 days ago
    thank you so much for your help!

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