Castillo Corporation has provided you with the following budgeted income statement for one of its products: $$\begin{array} { | l | r |}
\hline \text { Sales revenue } & \$ 700,000 \
\hline \text { Variable costs } & ( 430,000 ) \
\hline \text { Contribution margin } & \$ 270,000 \
\hline \text { Fixed costs } & ( 310,000 ) \
\hline \text { Operating loss } & \$ ( 40,000 ) \
\hline
\end{array}$$ Castillo has just encountered environmental problems with the product and will be forced to drop the product line altogether. Castillo will be able to eliminate 75% of the fixed costs. What will be the impact on operating income of the company?

Question

Castillo Corporation has provided you with the following budgeted income statement for one of its products: $$\begin{array} { | l | r |} 
\hline \text { Sales revenue } & \$ 700,000 \
\hline \text { Variable costs } & ( 430,000 ) \
\hline \text { Contribution margin } & \$ 270,000 \
\hline \text { Fixed costs } & ( 310,000 ) \
\hline \text { Operating loss } & \$ ( 40,000 ) \
\hline
\end{array}$$ Castillo has just encountered environmental problems with the product and will be forced to drop the product line altogether. Castillo will be able to eliminate 75% of the fixed costs. What will be the impact on operating income of the company?

Quizplus · Accepted Answer

The impact on operating income is calculated by considering the reduction in fixed costs and the loss of the contribution margin. Since 75% of the fixed costs ($310,000) can be eliminated, that amounts to a savings of $232,500 ($310,000 * 75%). However, dropping the product line also means losing its contribution margin of $270,000. The net impact is a decrease in operating income of $37,500 ($270,000 - $232,500).

Castillo Corporation Has Provided You with the Following Budgeted Income