EXERCISE 12 – 2 Dropping or Retaining a Segment [LO2]
Cumberland County Senior Services is a non -profit organization devoted to providing essential services to seniors who live in their own homes within the Cumberland County area. Three Th ree services are provided for seniors — home home nursing, Meals on Wheels, and housekeeping. In the home nursing program, nurses visit seniors on a regular basis to check on their general health and to perform tests ordered by their physicians. ph ysicians. The Meals on Wheels program delivers a hot meal once a day to each senior enrolled in the program. The housekeeping service provides weekly housecleaning and maintenance services. Data on revenue and expenses for the past year follow:
Revenues Variable expenses Contribution margin Fixed expenses: Depreciation Liability insurance Program administrators' salaries General administrative overhead* Total fixed expenses Operating income (loss)
Total $900,000 490,000 410,000
Nursing $260,000 120,000 140,000
Meals on Wheels $400,000 210,000 190,000
Housekeeping $240,000 160,000 80,000
68,000 42,000 115,000 180,000
8,000 20,000 40,000 52,000
40,000 7,000 38,000 80,000
20,000 15,000 37,000 48,000
405,000 $ 5,000
120,000 $ 20,000
165,000 $ 25,000
120,000 $(40,000)
*Allocated on the basis of program revenues. The head administrator of Cumberland County Count y Senior Services, Judith Ewa is concerned about the organization's finances and considers the operating income of $5,000 last year to be razorthin. (Last year's results were very similar to the results for previous years and are representative of what would be expected ex pected in the future.) She feels that the organization should be building its financial reserves at a more rapid rate in order ord er to prepare for the next inevitable inev itable recession. After seeing the above report, Ewa asked for more information about the financial advisability a dvisability of perhaps discontinuing the housekeeping program. Page 580 The depreciation in the housekeeping ho usekeeping category is for a small van that is used to carry the housekeepers and their equipment from job to job. If the program was discontinued, the van would be donated to a charitable organization. Depreciation charges assume zero salvage value. None of the general administrative overhead would be avoided if the housekeeping program was dropped, but the liability insurance and the salary of the program administrator would be avoided.
Required: 1. Should the housekeeping program be discontinued? Explain. Show computations to support your answer. 2. Recast the above data in a format that would be more useful to management in assessing the long-run financial viability of the various services.
SOLUTION Exercise 12-2
(30 minutes)
1. No, the housekeeping program should not be discontinued. It is actually generating a positive program segment margin and is, of course, providing a valuable service to seniors. Computations to support this conclusion follow: Contribution margin lost if the housekeeping program is dropped .......................................... Fixed costs that can be avoided: Liability insurance ............................................. $15,000 Program administrator’s salary ........................... 37,000 Decrease in operating income for the organization as a whole........................................................
$(80,000)
52,000 $(28,000)
Depreciation on the van is a sunk cost and the van has no salvage value since it would be donated to another organization. The general administrative overhead is allocated and none of it would be avoided if the program were dropped; thus it is not relevant to the decision. The same result can be obtained with the alternative analysis below: Total If House- Current keeping Is Total Dropped Revenues .................................... $900,000 $660,000 Variable expenses........................ 490,000 330,000 Contribution margin..................... 410,000 330,000 Fixed expenses: Depreciation ............................. 68,000 68,000 Liability insurance ..................... 42,000 27,000 Program administrators’ salaries 115,000 78,000 General administrative overhead 180,000 180,000 Total fixed expenses .................... 405,000 353,000 Operating income (loss) ............... $ 5,000 $(23,000)
Difference: Operating Income Increase or (Decrease) $(240,000) 160,000 (80,000) 0 15,000 37,000 0 52,000 $ (28,000)
Exercise 12-2
(continued)
2. To give the administrator of the entire organization a clearer picture of the financial viability of each of the organization’s programs, the general administrative overhead should not be allocated. It is a common cost that should be deducted from the total program segment margin. Following the format introduced in Chapter 11 for a segmented income statement, a better income statement would be:
Revenues ............................ Less Variable expenses ........ Contribution margin............. Traceable fixed expenses: Depreciation ..................... Liability insurance ............. Program administrators’ salaries .......................... Total traceable fixed expenses .......................... Program segment margins ... General administrative overhead .......................... Operating income (loss) ....... $
Total $900,000 490,000 410,000
Home Nursing $260,000 120,000 140,000
68,000 42,000
8,000 20,000
40,000 7,000
20,000 15,000
115,000
40,000
38,000
37,000
68,000 85,000 $ 72,000 $105,000
72,000 $ 8,000
225,000 185,000 180,000 (5,000)
Meals on House- Wheels keeping $400,000 $240,000 210,000 160,000 190,000 80,000
