AXD Company makes three types of t-shirts: Calm, Windy, and Gale. Mr. Brown, the

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AXD Company makes three types of t-shirts: Calm, Windy, and Gale. Mr. Brown, the general manager of the Company is disappointed with low sales and low profitability of Gale and is considering dropping the product. He believes that such a move will allow him to focus more attention to other profitable lines. He discusses this with you and asks for your opinion. You gather the following information about last year’s performance of the three products.

               Calm           Windy       Gale

Units Sold           25,000           18,750       3,750

Selling Price/unit       $ 30           $ 32       $ 39

Production Cost:

Direct Materials/unit       $ 10           $ 10       $ 15

Direct Labor/unit       $ 14           $ 14       $ 21  

There is no variable overhead. Annual total fixed overhead amounts to $ 168,000 and will remain the same whether the product line is dropped or retained. The fixed overhead rate established by the company was $ 3.60 per unit. . The analysis provided to Mr. Brown on the basis of which he was considering to drop Gale from the line of products sold was as follows:

`               Calm           Windy       Gale

Selling Price/unit       $ 30.00           $ 32.00       $ 39.00

Direct Materials/unit   ($ 10.00)   ($ 10.00) ($ 15.00)

Direct Labor/unit   ($ 14.00)   ($ 14.00) ($ 21.00)  

Fixed Overhead/unit ($ 3.60)   ($ 3.60) ($ 3.60)

              --------------------------------------------------------------------------

Operating profit per unit   $ 2.40           $ 4.40   ($ 0.60)

               =========================================

Given the foregoing information, what advice will you give to Mr. Brown? Explain the conceptual reasoning behind your advice. Also provide numerical analysis to support your explanation.

Explanation / Answer

1. Parsently Total fixed overhead amounts is $ 168,000 whereis the absorption rate is $3.6 per unit, that means total overhead absorbed by the Units produced are $171000( 47500 Units X $ 3.6) it means it is over absorbed by Rs $3000 ($171000-$168000).

If we consider this overabsorbed amount with the Gale Loss then there will be a operting gain of $ 750/- and overall profit will be $143250/-

2. If company opt to drop the production of this product then certanilly the burdon of Overhead Expenses will be born by Clain and wendy pproduct (25000+18750) = 43750 units i.e. per unit cost of Fixed overhead will be $ 3.84 and the total operating profit will be $ 132000 which is lower by $11250 ($143250-$132000)

So in this case it is advisale to continue the production of this GALE product and try to increase the production to lower the Fixed Ovedrhead Rate per unit.

Option 1st Calm            Windy       Gale Total Units Sold           25,000 18,750 3,750 47,500 Selling Price/unit        $   30 32 39 101 Total sale Price 750000 600000 146250 1496250 Production Cost: Less Direct Materials/unit        $   10 10 15 Total Direct material cost 250000 187500 56250 493750 Less Direct Labor/unit        $   14 14 21 Total labour cost 350000 262500 78750 691250 Less Fixed Overhead/unit $   3.6 3.6 3.6 Total fixed overhead cost 90000 67500 13500 171000 Less Operating profit per unit $ 2.4 4.4 -0.6 Add Overobserved Fixed Overhead 3000 3000 Overall Profit of the company 60000 82500 750 143250

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