Problem 12-26 Dropping or Retaining a Product
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. Ms. Douglas would like advice concerning the advisability of eliminating the model C3 lawnchair. These lawnchairs have been among the company’s best-selling products, but they seem to be unprofitable.
A condensed absorption costing income statement for the company and for the model C3 lawnchair for the quarter ended June 30 follows:
All Products Model C3 Lawnchair
Sales R 3,020,000 R 312,000
Cost of goods sold:
Direct materials 771,000 123,200
Direct labor 692,000 73,200
Fringe benefits (20% of direct labor) 138,400 14,640
Variable manufacturing overhead 29,200 4,800
Building rent and maintenance 31,200 5,200
Depreciation 76,200 20,300
Total cost of goods sold 1,738,000 241,340
Gross margin 1,282,000 70,660
Selling and administrative expenses:
Product managers' salaries 87,000 10,000
Sales commissions (5% of sales) 151,000 15,600
Fringe benefits (15% of salaries and commissions) 35,700 3,840
Shipping 132,000 15,820
General administrative expenses 465,200 49,200
Total selling and administrative expenses 870,900 94,460
Net operating income (loss) R 411,100 R (23,800)
The currency in South Africa is the rand, denoted here by R.
The following additional data have been supplied by the company:
a. Direct labor is a variable cost.
b. All of the company’s products are manufactured in the same facility and use the same equipment. Building rent and 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 lawnchair would have no effect on sales of other product lines.
e. Work in process and finished goods inventories are insignificant.
f. Shipping costs are traced directly to products.
g. General administrative expenses are allocated to products on the basis of sales. There would be no effect on the total general administrative expenses if the model C3 lawnchair were dropped.
h. If the model C3 lawnchair were dropped, the product manager would be laid off.
Required:
1a. Calculate the effect on the overall company's net operating income if the Model C3 lawnchair is dropped? (Input the amount as a positive value. Omit the "R" sign in your response.)
in net operating income R
1b. Would you recommend that the model C3 lawnchair be dropped?
Yes
No
2.
What would sales of the model C3 lawnchair have to be, at minimum, in order to justify retaining the product? (Omit the "R" sign in your response.)
Break-even point R
