Profits have been decreasing for several years at Pegasus Airlines. In an effort to improve the company’s performance, consideration is being given to dropping several flights that appear to be unprofitable.

Profits have been decreasing for several years at Pegasus Airlines. In an effort to improve the company’s performance, consideration is being given to dropping several flights that appear to be unprofitable.

  

A typical income statement for one round-trip of one such flight (flight 482) is as follows:

Ticket revenue (115 seats × 40%     occupancy × $60 ticket price)	$	2,760	100	%
Variable expenses ($12.00 per person)		552	20
Contribution margin		2,208	80	%
Flight expenses:
Salaries, flight crew	$	380
Flight promotion		680
Depreciation of aircraft		410
Fuel for aircraft		195
Liability insurance		300
Salaries, flight assistants		710
Baggage loading and flight preparation		180
Overnight costs for flight crew and      assistants at destination		80
Total flight expenses		2,935
Net operating loss	$	(727)

The following additional information is available about flight 482:

a.	Members of the flight crew are paid fixed annual salaries, whereas the flight assistants are paid based on the number of round trips they complete.
b.	One-third of the liability insurance is a special charge assessed against flight 482 because in the opinion of the insurance company, the destination of the flight is in a "high-risk" area. The remaining two-thirds would be unaffected by a decision to drop flight 482.
c.	The baggage loading and flight preparation expense is an allocation of ground crews' salaries and depreciation of ground equipment. Dropping flight 482 would have no effect on the company's total baggage loading and flight preparation expenses.
d.	If flight 482 is dropped, Pegasus Airlines has no authorization at present to replace it with another flight.
e.	Aircraft depreciation is due entirely to obsolescence. Depreciation due to wear and tear is negligible.
f.	Dropping flight 482 would not allow Pegasus Airlines to reduce the number of aircraft in its fleet or the number of flight crew on its payroll.

 

Required:

1.

Prepare an analysis showing what impact dropping flight 482 would have on the airline's profits.   Explanation: 1. The following costs are not relevant to the decision: Cost Reason   Salaries, flight crew   Fixed annual salaries, which will not change.   Depreciation of aircraft   Sunk cost.   Liability insurance (two-thirds)   Two-thirds of the liability insurance is unaffected by this decision   Baggage loading and flight   preparation   This is an allocated cost that will continue even if the flight is   discontinued. Liability insurance (1/3 × $300) = $100 Alternative Solution:     Keep the Flight   Drop the Flight Difference: Net Operating Income Increase or (Decrease)   Ticket revenue $ 2,760   $ 0   $ (2,760)      Variable expenses   552     0     552        Contribution margin   2,208     0     (2,208)        Less flight expenses:                 Salaries, flight crew   380     380     0        Flight promotion   680     0     680        Depreciation of aircraft   410     410     0        Fuel for aircraft   195     0     195        Liability insurance   300     200     100        Salaries, flight assistants   710     0     710        Baggage loading and flight preparation   180     180     0        Overnight costs for flight crew and assistants at destination   80     0     80        Total flight expenses    2,935     1,170     1,765        Net operating loss $ (727)   $ (1,170)   $ (443)