Question

UPA adapted 24-11. Effect of product mlx variation. The officers of the Herbert Company reviewed the ability of the company's four products and the potential effect of several proposals for va product mix. An excerpt from the year's income statement and other data follows varying the PROOUGT TOTAL P Sales. Cost of goods sold .. Gross profit. Operating expense. $62,600 S10,000 $18,000 $12.600 $22.000 44.274 4,750 7.05 13,968 18,500 $18.326 5,250 S10.944 $(1.368) 3.500 4,220 Profit before income tax.. Units sold Sales price per unit . Variable cost of goods sold per unit Variable operating expense per unit 12,012 990 2.976 2.826 8,314 $ 3,260 $ 7.968 (4.194) 1,000 1,200 1.800 $2.50 $3.00 6.50 720) 2,000 $10.00 $15.00 $7.00 $11.00 6.00 1,17 $1.25 1.00 $1.20 The total fixed cost is not expected to fluctuate as a result of changes under consideration Required: (1) The eftect on profit if R is discontinued (2) The effect on profit if R is discontinued and if a consequent loss of customers causes a (3) The effect on profit if R's sales price is increased to $8, and the number of units sold decrease of 200 units in sales of Q decreases to 1,500 with no effect on the other products (4) The effect on profit if a new product, T, is introduced and R is discontinued with no effect on the other products. (The total variable cost per unit of Product T would be $8.05, and 1,600 units can be sold at $9.50 each. The plant in which R is produced can be utilized to produce T.) (5) The effect on profit if production of P is reduced to 500 units (to be sold at $12 each) and if production of S is increased to 2,500 units (to be sold at $10.50 each). (Part of the plant in which P is produced can easily be adapted to produce S, but changes in quantities make changes in the sales price advisable.) (6) The effect on profit if production of P is increased by 1,000 units to be sold at $10 each by adding a second shift. (Higher wages must be paid, thus increasing the variable cost goods sold per unit to $3.50 for each additional unit.) of (AICPA adapted] cor anias are each nroduciea and selling annualy

Answer 1

In order to analyse the contribution by each product into the total profits, we need to first compute variable costs and contribution margin for each product.

Table 1: Calculation of Contribution per unit of each product, and Total Fixed Cost

Product	P	Q	R	S
Sales (in $)	10,000	18,000	12,600	22,000
Sales (in units)	1,000	1,200	1,800	2,000
Selling price per unit	10	15	7	11
Variable cost per unit (Variable COGS + Variable OpEx) ...(given)	3.67	4.25	7.50	7.20
Contribution per unit (Selling Price- Variable Cost)	6.33	10.75	(0.50)	3.80
Total Contribution (Contribution per unit * Sales (in units)	6,330	12,900	(900)	7,600
Profit before interest and tax (PBIT) ... (given)	3,260	7,968	(4,194)	(720)
Fixed Cost (Total Contribution - PBIT)	3,070	4,932	3,294	8,320

(1) Effect on Profit if R is discontinued

If R gets discontinued, the fixed cost allocated to R would continue to be incurred as it is not expected to fluctuate given any change (as provided in the question). Therefore, on discontinuation of R, the company would save the loss (i.e., the excess of variable cost over sales) being incurred. Hence, discontinuation of R would result in an increase of $900 in the Profit.

(2) Effect on Profit if R is discontinued and consequent decrease by 200 units in sales of Q

In this case, loss of sales of 200 units of Q would result into loss of contribution (or profit, as the fixed cost would remain same) of $760 (that is, $3.80 per unit for 200 units). However, as computed in (1) above, discontinuation of R would result in an increase of $900 in the profit. Hence, in the given case, the total impact on profit would be an increase of $140.

(3) If price of R = $8 and Sales quantity of R = 1500 units

In this case, the contribution per unit of product R would increase to $0.50 per unit (i.e., $8 - $7.50). Therefore, the total contribution by R would be $0.50 per unit for 1500 units, that is, $750. Hence, keeping other things constant, this would result in an increase in the profit by $1,650 (i.e., $750 - ($900)).

(4) If R is discontinued and T is introduced

Increase in the profit due to discontinuation of R = $900 (as computed in (1)).

Change in profit due to introduction of T:

Particulars	Amount
Selling price per unit	9.50
Variable Cost per unit	8.05
Contribution per unit (Selling price - variable cost)	1.45
Sales (units)	1,600
Contribution (in $)	2,320
Additional Fixed Cost (existing facilities to be used)	-
Incremental Profit due to introduction of T (Contribution - Additional Fixed Cost)	2,320

Therefore, in the given case, there would be an increase in the profit by ($900 + $ 2,320, i.e.,) $3,220.

(5) Effect on Profit on change in sales quantities and prices of P and S

Calculation of Profit from Sales of P and S based on the given scenario

Particulars	P	S
Selling price per unit	12	10.50
Variable Cost per unit (from above)	3.67	7.20
Contribution per unit (Selling price - Contribution)	8.33	3.30
Sales (in units)	500	2,500
Total Contribution (Contribution per unit * Sales quantity)	4,165	8,250
Fixed Cost (fixed cost would remain same, as existing facilities to be used)	3,070	8,320
Profit before interest and tax (Total Contribution - Fixed Cost)	1,095	(70)
Existing profit before interest and tax	3,260	(720)
Change in profit before interest and tax	(2,165)	650

Therefore, If P and S would be produced as per the given scenario, the Profit would reduce by $1,515 (i.e., -2,165 + 650).

(6) Increase in production of P by second shift working

Computation of Incremental profit on production and sale of the additional 1,000 units

Particulars	Amount
Existing Contribution per unit of P	6.33
Increase in variable cost of goods sold per unit due to high wages (3.50-2.50)	1.00
Revised Contribution per unit for additional 1,000 units	5.33
Therefore, profit on sale of additional 1,000 units ($5.33*1,000) (since no additional fixed cost will have to be incurred)	5,330

Production of P in the second shift, as given, will result in incremental profit of $5,330.