Camera Corner is considering eliminating Model AE2 from its camera line because of losses over the past quarter. The past three months of information for Model AE2 are summarized below: Overhead costs are 70% variable and the remaining 30% is depreciation of special equipment for model AE2 that has no resale value.
If Model AE2 is dropped from the product line, operating income will:
A)increase by $10,000
B)decrease by $20,000
C)increase by $30,000
D)decrease by $10,000

Question

Camera Corner is considering eliminating Model AE2 from its camera line because of losses over the past quarter. The past three months of information for Model AE2 are summarized below:  Overhead costs are 70% variable and the remaining 30% is depreciation of special equipment for model AE2 that has no resale value.
If Model AE2 is dropped from the product line, operating income will:
A)increase by $10,000 
B)decrease by $20,000 
C)increase by $30,000 
D)decrease by $10,000

Quizplus · Accepted Answer

The total cost of Model AE2 over the past quarter is $60,000 ($20,000 in fixed costs and $40,000 in variable costs). Since 70% of the overhead costs are variable costs, dropping the product line will result in a $28,000 decrease in costs. However, the special equipment depreciation of $2,000 cannot be recovered and will lead to a decrease in operating income of $20,000 ($28,000 - $2,000). Therefore, the operating income will decrease by $20,000 if Model AE2 is dropped from the product line.

Camera Corner Is Considering Eliminating Model AE2 from Its Camera