Tracey Douglas is the owner and managing director of Heritage Garden Furniture L
ID: 2550258 • Letter: T
Question
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 R1,600,000* R 6,800,000 Cost of sales Direct materials Direct labour Fringe benefits (20% of direct labour) Variable manufacturing overhead Building rent and maintenance Depreciation 640,000 384,000 76,800 19,200 20,800 102,400 1,768,000 1,564,000 312,800 68,000 68,000 170,000 3,950,800 Total cost of sales Gross margin Selling and administrative expenses 1,243,200 356,800 2,849,200 Product managers' salaries Sales commissions (5% of sales) Fringe benefits (20% of salaries and commissions) Shipping 52,800 80,000 26,560 23,000 256,000 170,000 340,000 102,000 272,000 1,088,000 General administrative expenses Total selling and administrative expenses Net operating income (loss) 438,360 1,972,000 R (81,560) R 877,200 The currency in South Africa is the rand, denoted here by R. The following additional data have been supplied by the company: a. Direct labour is a variable cost at Heritage Garden Furniture b. All of the company's products are manufactured in the same facility and use the same equipment. Building rent, maintenance, and depreciation are allocated to products using various bases. The equipment does not wear out through use; it eventually becomes obsolete c. There is ample capacity to fill all orders d. Dropping the model C3 lawn chair would have no effect on sales of other product lines e. Inventories of work in process or finished goods are insignificant. f. Shipping costs are traced directly to products g. General administrative expenses are allocated to products on the basis of sales dollars. There would be no effect on the total general administrative expenses if the model C3 lawn chair were dropped h. If the model C3 lawn chair were dropped, the product manager would be laid offExplanation / Answer
Step 1
Important points to be remembered
Step 2
We must know expenses which can be avoided if Model C3 Lawn Chair is dropped to calculate the net operating income after dropping this product
If Model C3 Lawn Chair is dropped, all variable expenses related to production and sales can be avoided
1. Direct Material
2. Direct Labour
3. Fringe benefits(% of direct labour)
4. Variable Manufacturing Overhead
5. Sales Commission
6. Fringe benefits(% on sales commission)
7. Shipping costs
Any expense which is related only to this product can be avoided
1. Production Manager’s Salary (he will be laid off if Model C3 Lawn chair is dropped)
Step 3
Now calculate Each avoidable expenses’ value which will help us to prepare to the income statement after dropping Model C3 Lawn chair
Value of the avoidable expenses if we drop Model C3 Lawn chair
Direct materials
640,000
Direct labour
384,000
Fringe benefits
76,800
Variable manufacturing overhead
19,200
Sales commission
80,000
Fringe benefits
26,560
Shipping
23,000
Product manager’s salary
52,800
1,302,360
Step 4
Question 1: At current level of sales, compute the effect of net operating income if the Model C3 Lawn Chair is dropped
Particulars
Before model C3 Lawn chair is dropped (A)
Avoidable costs if Model C3 is dropped (B)
after dropping Model C3 Lawn Chair (A) - (B)
Sales
6800000
1,600,000
5,200,000
Cost of Sales:
i. Direct Materials
1768000
640000
1,128,000
ii. Direct Labour
1564000
384000
1,180,000
iii. Fringe Benefits (20% of direct labour)
312800
76800
236,000
iv. Variable Manufacturing overhead
68000
19200
48,800
v. Building rent and maintenance
68000
68,000
vi. Depreciation
170000
170,000
Total cost of Sales
3950800
1120000
2,830,800
Gross Margin
2849200
480000
2,369,200
Selling Administrative Expenses:
i. Product Manager’s salaries
170000
52800
117,200
ii. Sales commission(5% of sales)
340000
80000
260,000
iii. Fringe Benefits (20% of salaries and commission)
102000
26560
75,440
iv. Shipping
272000
23000
249,000
v. General administrative expenses
1088000
1,088,000
Total selling and administrative expenses
1972000
182360
1,789,640
Net operating income
877200
297640
579,560
By Dropping Model C3 Lawn Chair, the company will lose a profit of R 297640.
Question 2: Would you recommend that the Model C3 Lawn Chair be dropped?
Hence it is not advisable to drop this product. Because this product is really profitable.
Question 3: What should be the sales of the Model C3 Lawn Chair at minimum to retain the product?
It is a question of calculating break even sales of this product.
We should find out how much sales should be made to cover the variable cost and fixed cost allocated to this product.
That sales level is known as break even sales.
To calculate Break Even Sales
We need the following for Model C3 Lawn Chair
1.Sales
2.Variable Cost
3.Fixed expenses allocated
4.Contribution Margin
Step 1: To know the above, we will prepare contribution Margin Income Statement
Contribution Margin Income Statement
Sales
1,600,000
Less: Variable Cost:
Direct materials
640,000
Direct labour
384,000
Fringe benefits
76,800
Variable manufacturing overhead
19,200
Sales commission
80,000
Fringe benefits
26,560
Shipping
23,000
Product manager’s salary
52,800
1,302,360
Contribution Margin
297,640
Less: Fixed Cost:
Building rent and maintenance
20,800
Depreciation
102,400
General Administrative expenses
256,000
379,200
Net Operating Loss
(81,560)
Step 2: Calculation of Break Even Sales
Break Even Sales = Fixed Cost / Contribution Margin Ratio
(i) FixedCost = 379,200
(ii) Contribution Margin Ratio = Contribution Margin / Sales x 100
= 297640/1600000*100 = 18.60%
(iii) Break Even Sales = Fixed Cost / Contribution Margin Ratio
= 379200/18.60%
= R 2,038,710
Answer: The minimum sales to be maintained to retain the product is R 2,038,710. Because in this Sales level, the entire variable and fixed cost is covered. There will be no profit or no loss.
Direct materials
640,000
Direct labour
384,000
Fringe benefits
76,800
Variable manufacturing overhead
19,200
Sales commission
80,000
Fringe benefits
26,560
Shipping
23,000
Product manager’s salary
52,800
1,302,360
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.