5 value: 10.00 points Problem 9-2 Deciding Whether to Add or Drop a Product (LO1

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5 value: 10.00 points Problem 9-2 Deciding Whether to Add or Drop a Product (LO1 CC3) Tracey Douglas is the owner and managing director of Heritage Garden Furniture Ltd., a South African company that makes museum-quality reproductions of antique outdoor furniture. Tracey would like advice concerning the advisability of eliminating the model C3 lawn chair. These lawn chairs have been among the company's best-selling products, but they seem unprofitable A condensed statement of operating income for the company and for the model C3 lawn chair for the quarter ended June 30 follows Model C3 Lawn Chair All Products Sales R 800,000 R 4,400,000 Cost of sales Direct materials Direct labour Fringe benefits (20% of direct labour) Variable manufacturing overhead Building rent and maintenance Depreciation 320,000 192,000 38,400 9,600 10,400 51,200 1,144,000 1,012,000 202,400 44,000 44,000 110,000 Total cost of sales Gross margin Selling and administrative expenses 621,600 2,556,400 178,400 1,843,600 Product managers' salaries Sales commissions (5% of sales) Fringe benefits (20% of salaries and commissions) Shipping 26,400 40,000 13,280 15,000 128,000 110,000 220,000 66,000 176,000 704,000 General administrative expenses Total selling and administrative expenses Net operating income (loss) 222,680 1,276,000 R (44,280) R 567,600 The currency in South Africa is the rand, denoted here by R

Explanation / Answer

1a)If Model C3 is dropped ,there will no contribution .Also product manager salary(including fringe benefit ),Shipping cost will be avoidable as it is directly Traceable to product.

Allocated fixed cost that will continue to be incurred even if product is dropped : 10400 +51200+ 128000 = 189600

Loss if product C3 is dropped : (189600)

Increase in loss : 189600- 44280 = $ 145320

Net operating income will decrease by $ 145320

1b)No,C3 should not be dropped.

2)contribution margin ratio : contribution /sales

                 = 192000 /800000

             = .24 or 24%

Relevant fixed cost : 26400 Product manager salaries +[26400*20%] Fringe benefit +15000 shipping

              = 46680

Sales volume : Fixed cost /contribution margin ratio

           = 46680/.24

           = R 194500

**Allocated fixed cost is not taken while calculating break even point for segment as it is an allocated cost incurred at corporate level and not directly traceable to product .

Model C3 Lawn chair sales 800000 less:Variable cost Direct material 320000 Direct labor 192000 Fringe benefit 38400 variable manufacturing overhead 9600 sale commission 40000 Fringe benefit [on sales commission][40000*.20] 8000 Total variable cost 608000 contribution margin 192000

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