Lessons · Accounting · dropping a product line
Dropping a product line
A line is worth keeping if its contribution exceeds the fixed costs that would actually disappear with it. Allocated common costs do not disappear; they move onto whatever is left.
Hone is a place to practise a career, one idea a day. This is one of its lessons, written out in full and free to read without an account.
In beta. This lesson was written for Hone and has not yet been checked by a qualified accountant. Practice material, not professional advice. What that means.
What it is for
This is where the allocated-cost error does the most damage, because acting on it destroys real profit. A line shows a loss after its share of head office, the business closes it, head office costs the same as before, and next year the remaining lines carry more overhead and one of them now shows a loss too.
How to think about it
Take the line's contribution. Subtract only the fixed costs that would genuinely end. If what remains is positive, the line is paying something towards the common costs and closing it makes the business worse off by exactly that amount.
Worked example
Sales 80,000, variable 62,000, so contribution 18,000What the line brings in above its own variable costs.
Avoidable fixed costs 12,000The line manager's salary, its own equipment lease.
Allocated head office 15,000Continues whatever happens. Not part of this decision.
18,000 − 12,000 = 6,000 towards common costs. Keep itOn the reported figures it looked like a 9,000 loss, and closing it would have cost 6,000 a year.
Your turn
Contribution 18,000 and avoidable fixed 12,000. Write the line for what the product contributes to common costs.
18,000 − = 6,000 towards common costs
Solve one, graded on the server
The trap
Reading the bottom line of a product-level income statement that has common costs allocated into it. That statement is built for reporting, not for this decision, and taken at face value it recommends closing lines that are paying their way.