Harmark has three product lines in its retail stores: kites, wind socks, and flags. Results of the fourth quarter are presented below: Kites Wind Socks Flags Total Units sold 1,000 2,000 2,000 5,000 Revenue $ 22,000 $ 40,000 $ 23,000 $ 85,000 Variable departmental costs 17,000 22,000 12,000 51,000 Direct fixed costs 1,000 3,000 2,000 6,000 Allocated fixed costs 8,000 8,000 8,000 24,000 Net income (loss) $ (4,000 ) $ 7,000 $ 1,000 $ 4,000 The allocated fixed costs are unavoidable. Demand of individual products is not affected by changes in other product lines. What will happen to profits if Harmark discontinues the Kites product line?

If Kites is discontinued, Harmark's net income will be reduced by $4,000

Explanation:

Relevant cost are future incremental cash costs that arise as a direct consequence of a decision.

The relevant costs of this decision to dis includes discontinue he following:

1.The contribution lost (22,000 -17000)   =           (5,000)

2.  savings in the avoidable fixed cost                       1000

The net loss from decision                                           (4,000)

If Kites is discontinued, Harmark net income will be reduced by $4,000

Note that we did not consider the allocated fixed cost of 8000 because they would be incurred either way. And therefore they are not relevant for this decision

Overall profits will be reduced by $4000

Explanation:

First is important to notice that the allocated fixed costs are unavoidable. Thus discontinuing the Kite product line will not prevent the fixed costs being incurred.

Currently Harmark is making revenue of $22000 from the sale of kites. Variable costs for the kites are $17000.

Contribution before fixed costs = $ 5000

Direct fixed costs ($1000)

Contribution remaining $4000

Allocated fixed costs ($8000)

If the kite range is discontinued the company will reduce profits by $4000 as there are unavoidable allocated fixed costs of $8000. Currently the Kite product range contributes to $4000 of this cost.

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