Question

A. A Company has three operating divisions. Each division manager’s performance evaluation and bonus is based on his or her own specific division’s total operating income. The EASTERN Division makes two products: A and B. The CENTRAL Division makes product C and the WESTERN Division makes product D. All four products use direct labor and direct materials. However, fixed (unavoidable) corporate overhead is allocated to each product based on direct labor cost. The total fixed corporate overhead cost is $1,825. The partial operating income statement below is for the first quarter of the year.

	Product A	Product B	Product C	Product D
Netsales	1,250	950	1100	1450
Direct Materials	200	50	105	160
Direct Labor	350	700	462	588
Overhead	?	?	?	?
Net Income	?	?	?	?

B.Assume you are the manager of the EASTERN Division. You announce to management that starting in the second quarter, you are discontinuing product B, replacing it with nothing, letting the labor go, and cutting all direct costs attributable to the product. You reasoned that product B is losing money for your division and the company (a hint for part 1). Assume that no fixed corporate overhead can be eliminated by eliminating product B. Based on your decision to eliminate product B, re-compute first-quarter operating income for the remaining products and for the company in total.

C. Manager compensation is based on salary plus a bonus of 10% of their divisional operating income. YOU ARE THE MANAGER of the EASTERN Division. Are YOU, personally, better off by eliminating product B? Make computations to support your answer.

Answer 1

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	Product A	Product B	Product C	Product D	Total
Net Sales	$      1,250	$        950	$     1,100	$      1,450	$    4,750
Less:
Direct Materials	$         200	$           50	$        105	$         160	$       515
Direct Labor	$         350	$        700	$        462	$         588	$    2,100
Overhead ($1,825 in Direct Labor cost ratio)	$         304	$        608	$        402	$         511	$    1,825
Net Income	$         396	$       -408	$        132	$         191	$       310
Part B
	Product A	Product B	Product C	Product D	Total
Net Sales	$      1,250		$     1,100	$      1,450	$    3,800
Less:
Direct Materials	$         200		$        105	$         160	$       465
Direct Labor	$         350		$        462	$         588	$    1,400
Overhead ($1,825 in Direct Labor cost ratio in A,C and D)	$         456		$        602	$         767	$    1,825
Net Income	$         244	$            -	$         -69	$          -65	$       110
Part C
No, Since overall operating income has come down from $310 to $110.
elimination of product B is not justifiable since loss is coming just due to allocated overhead which can not be eliminated