DM Corporation has provided you with the following budgeted income statement for one of their products: $$\begin{array} { | l | r | }
\hline \text { Sales } & \$ 700,000 \
\hline \text { Variable expenses } & ( 430,000 ) \
\hline \text { Contribution margin } & \$ 270,000 \
\hline \text { Fixed expenses } & \underline { ( 300,000 ) } \
\hline \text { Operating loss } & \underline { ( \$ 30,000 } ) \
\hline
\end{array}$$ DM has just encountered environmental problems with the product and will be forced to drop the product line altogether. They will be able to eliminate 75% of the fixed expenses. What will be the impact on operating income of the company?

Question

DM Corporation has provided you with the following budgeted income statement for one of their products: $$\begin{array} { | l | r | } 
\hline \text { Sales } & \$ 700,000 \
\hline \text { Variable expenses } & ( 430,000 ) \
\hline \text { Contribution margin } & \$ 270,000 \
\hline \text { Fixed expenses } & \underline { ( 300,000 ) } \
\hline \text { Operating loss } & \underline { ( \$ 30,000 } ) \
\hline
\end{array}$$ DM has just encountered environmental problems with the product and will be forced to drop the product line altogether. They will be able to eliminate 75% of the fixed expenses. What will be the impact on operating income of the company?

Quizplus · Accepted Answer

Since the product line is being dropped, the sales, variable expenses, and contribution margin will all become zero. Therefore, the only impact on operating income will be the reduction in fixed expenses. The new fixed expenses will be $300,000 x 0.25 = $75,000. Operating loss will decrease by $300,000 - $75,000 = $225,000. Therefore, the new operating loss will be -$30,000 - $225,000 = -$255,000. The impact on operating income will be a decrease of $45,000 ($255,000 - (-$30,000)). Therefore, the correct answer is B.

DM Corporation Has Provided You with the Following Budgeted Income