Use the information below to answer the following question(s):
Pottery Unlimited has two product lines: cups and pitchers. Income statement data for the most recent year follow:

-If $20,000 of Pottery Unlimited's fixed costs will be eliminated by dropping the Pitcher line, how will operating income be affected?

Question

Use the information below to answer the following question(s):
Pottery Unlimited has two product lines: cups and pitchers. Income statement data for the most recent year follow:
 
-If $20,000 of Pottery Unlimited's fixed costs will be eliminated by dropping the Pitcher line, how will operating income be affected?

Quizplus · Accepted Answer

The contribution margin per unit for pitchers is $30 - $16 = $14, while for cups it is $10 - $5 = $5. This means that the company is making more profit per unit sold for pitchers than for cups.

If the company drops the pitcher line, it will lose $36,000 in sales revenue ($6 x 6,000 units) but it will eliminate $20,000 in fixed costs. This means that its total contribution margin will decrease by $16,000 ($14 x 6,000 units - $5 x 6,000 units).

Therefore, its operating income will decrease by $4,000 ($16,000 - $20,000).

Hence, the correct answer is C) Decrease $10,000.

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