Question

Adm2341 Co. manufactures and sells two products (A and B). Projected data for next year are: Product A Product B Sales in units 15,000 10,000 Sale price per unit $100 $160 Variable costs manufacturing 50% of sales 60 % of sales Sales commissions 20 % of sales 20 % of sales Advertising $100,000 $120,000 Other fixed costs (note 1) $240,000 $240,000 Note 1: Each amount of "Other fixed costs" includes $100,000 fixed general overhead allocated by the Headquarter of Adm2341 Co. to each product. The remaining costs are traceable fixed costs to each product. Adm2341 Co. anticipates no change in the operating result for Product B in the foreseeable future if the product is manufactured. However, Adm2341 Co. is re-examining all of its products and is trying to decide whether or not to discontinue Product B. REQUIRED: 1. Prepare an income statement in Contribution margin format showing the segment margin for each product and operating income for Adm2341 Co. as a whole. 2. Assume that discontinuing the production and sale of Product B will not affect the sale of Product A. If the company drops Product B, what will be the change in annual operating income due to this decision? 3. Assume that discontinuing Product B result in an increase of $200,000 in sales of Product A. There will be no increase in advertising expenses. The variable cost structure stays unchanged. If Adm2341 Co. drops Product B, what will be the impact in operating income next year due to this decision? Do you recommend dropping or not product B? Why? 4. Top management of Adm2341 Co. decided not to drop Product B. Assume that the maximum production capacity of Adm2341 Co. is limited to 18,000 Hours and the production of one unit of Product A requires 0.50 hours and one unit of Product B requires 1.25 Hours. The market demand is 15,000 units for Product A and 10,000 units for Product B. a) Is here enough capacity to meet the market demand for each product? b) Compute the contribution margin per hour for each product? c) What is the optimal solution do you suggest for Product A and Product B d) Present the income statement according to your optimal solution.

Answer 1

Product A Total Product B 160 100% Particulars Sales Price Less. Variable Costs Manufacturing Cost Sales Commission 96 500 20 32 30 Contribution Margin p.u. (a) No. of Unit sold (b) Total Contribution © (a*b) Less. Advertising Expenses Less. Allocable Other Fixed Cost Less. Remaining Fixed Cost - Traceable Operating Income 15,000 4,50,000 1,00,000 1,00,000 1,40,000 1,10,000 10,000 3,20,000 1,20,000 1,00,000 1,40,000 -40,000 7,70,000 2,20,000 2,00,000 2,80,000 70,000 2 If Product B is discontinued, Operating Result would be Contribution Margin (a) 30 No. of Unit sold (b) 15,000 Total Contribution © (a*b) 4,50,000 Less. Advertising Expenses 1,00,000 Less. Allocable Other Fixed Cost 2,00,000 Less. Remaining Fixed Cost - Traceable 1,40,000 Operating Income 10,000 The Income will decline by $60,000 as the allocable fixed cost will be apportioned to this product only in the absence of Product B Production & Sales 3 Discontinuing Product B - Results in increase in sales by $200,000 i.e. 2000 Units Contribution Margin (a) 30 No. of Unit sold (b) (15000 + (200000/100) 17,000 Total Contribution © (a*b) 5,10,000 Less. Advertising Expenses 1,00,000 Less. Allocable Other Fixed Cost 2,00,000 Less. Remaining Fixed Cost - Traceable 1,40,000 Operating Income 70,000 The Operatng Profit is same in this case as computed in point 1, We recommed to discontinue Product B, if Sales are probable to increase by $200,000 Maximum Production Capacity 18,000 Hours Production of Product A requires Production of Product B requires 0.5 Hours 1.25 Hours Demand 15,000 10,000 (a) Total Capacity Required is calculated below Product А. Units 15000 10000 0.5 Hours p.u. Total reqd hours 7,500 1.25 12,500 20,000 Total No, there is not enough capacity to produce 15000 Units of Product A & 10000 Units of Product B (b) Product A Product B Contribution Margin Per Hour Particulars Contribution Margin(per unit) divided by No. of Hours to produce 1 Unit Contribution margin per hour 30 32 0.5 60.00 1.25 25.60 Optimal Solution Produce Product A first, then allocate balance number of hours in Product B Product Hour p.u Hours Units Produced 15,000 8,400 A 0.5 1.25 B 7,500 10,500 18,000 Total Produce Product A - 15000 Units & Product B - 8400 Units (d) Total Product B 8,400 160 13,44,000 28,44,000 Income Statement as per the optimal Solution Particulars Product A Sales Units 15,000 Sales Price 100 Total Sales 15,00,000 Less. Variable Cost Manufacturing Cost @ 50%/60% 750000 Sales Commission @ 20%/20% 300000 Contribution 4,50,000 Less. Fixed Costs Advertising 100000 Other Fixed Cost 240000 Net result 1,10,000 806400 268800 2,68,800 15,56,400 5,68,800 7,18,800 120000 240000 -91,200 2,20,000 4,80,000 18,800