Product Costing, Cost Estimation, and Decision Making
I don’t understand this. Last year [year 1], we decided to drop our highest-end Red model and only produce the Yellow and Green models, because the cost system indicated we were losing money on Red. Now, looking at the preliminary numbers, our profit is actually lower than last year and it looks like Yellow has become a money loser, even though our prices, volumes, and direct costs are the same. Can someone please explain this to me and maybe help me decide what to do next year?
Robert Dolan
President & CEO
Dolan Products
Dolan Products is a small, family-owned audio component manufacturer. Several years ago, the company decided to concentrate on only three models, which were sold under many brand names to electronic retailers and mass-market discount stores. For internal purposes, the company uses the product names Red, Yellow, and Green to refer to the three components.
Data on the three models and selected costs follow:
This year (year 2), the company only produced the Yellow and Green models. Total overhead was $650,000. All other volumes, unit prices, costs, and direct labor usage were the same as in year 1. The product cost system at Dolan Products allocates manufacturing overhead based on direct labor-hours.
Required
- a. Compute the product costs and gross margins (revenue less cost of goods sold) for the three products and total gross profit for year 1.
- b. Compute the product costs and gross margins (revenue less cost of goods sold) for the two remaining products and total gross profit for year 2.
- c. Should Dolan Products drop Yellow for year 3? Explain.
a.
Compute the product costs and gross margins for the three products and total gross profit for year 1.
Answer to Problem 62IC
The values of product costs and gross margins for the three products and total gross profit for Year 1 are as follows:
Particulars | Red | Yellow | Green |
Product Cost | $ 978,571 | $ 914,286 | $ 907,143 |
Gross Profit | ($ 228,571) | $ 85,714 | $ 592,857 |
Gross margin | $200,000 | $300,000 | $700,000 |
Table: (1)
Explanation of Solution
Gross margin: Gross margin is calculated by subtracting the cost of goods sold (COGS) from the revenue of the business. It defines the profit earned only because of the production of the goods. It does not account for indirect expenses. It is also known as gross profit.
Total product cost: It includes direct materials cost, direct labor cost, and manufacturing overhead (MOH).
Compute the total product cost:
For Product Red:
For Product Yellow:
For Product Green:
Thus, the values of the total cost for Product Red, Yellow and Green are $978,571, $914,286 and $907,143 respectively.
Compute the gross margins and gross profit for the three products and total gross profit for year 1:
Year 1 | ||||
Particulars | Red | Yellow | Green | Total |
Sales Revenue: | $ 750,000 | $ 1,000,000 | $ 1,500,000 | $ 3,250,000 |
Less: Variable cost | $ 550,000 | $ 700,000 | $ 800,000 | $ 2,050,000 |
Gross Margin | $ 200,000 | $ 300,000 | $700,000 | $ 1,200,000 |
Less: Fixed manufacturing overhead | $ 428,571 | $ 214,286 | $ 107,143 | $ 750,000 |
Gross profit | ($ 228,571) | $ 85,714 | $ 592,857 | $ 450,000 |
Table: (2)
Compute the gross margin:
For Product Red:
For Product Yellow:
For Product Green:
Thus, the value of gross margin for the Product Red, Yellow and Green are $200,000, $300,000 and $700,000 respectively.
Compute the gross profit:
For Product Red:
For Product Yellow:
For Product Green:
Thus, the values of gross profit for the Product Red, Yellow and Green are ($228,571), $85,714 and $592,857 respectively.
Working note 1:
Compute the variable cost For Product Red:
Working note 2:
Compute the variable cost For Product Yellow:
Working note 3:
Compute the variable cost For Product Green:
Working note 4:
Compute the fixed manufacturing overhead For Product Red:
Working note 5:
Compute the fixed manufacturing overhead For Product Yellow:
Working note 6:
Compute the fixed manufacturing overhead For Product Green:
b.
Compute the product costs and gross margins for the two products and total gross profit for year 2.
Answer to Problem 62IC
The product costs and gross margins for the two products and total gross profit for year 2 are as follows:
Particulars | Yellow | Green |
Total Cost | $ 1,133,333 | $ 1,016,667 |
Gross Profit | $ (133,333) | $ 483,333 |
Gross margin | $ 300,000 | $ 700,000 |
Table: (3)
Explanation of Solution
Gross margin: Gross margin is calculated by subtracting the cost of goods sold (COGS) from the revenue of the business. It defines the profit earned only because of the production of the goods. It does not account for indirect expenses. It is also known as gross profit.
Total product cost: It includes direct materials cost, direct labor cost, and manufacturing overhead (MOH).
Compute the total product costs For Product Red:
Thus, the value of total production costs for Product Green is $978,571.
Compute the total product costs For Product Yellow:
Thus, the value of total production costs for Product Yellow is $914,286.
Compute the total product costs For Product Green:
Thus, the value of total production costs for Product Green is $907,143.
Compute the gross margins for the three products and total gross profit for year 2:
Year 2 | |||
Particulars | Yellow | Green | Total |
Sales Revenue | $ 1,000,000 | $ 1,500,000 | $ 2,500,000 |
Less: Variable cost | $ 700,000 | $ 800,000 | $ 1,500,000 |
Gross Margin | $ 300,000 | $ 700,000 | $ 1,000,000 |
Less: Fixed manufacturing overhead | $ 433,333 | $ 216,667 | $ 650,000 |
Gross profit | $ (133,333) | $ 483,333 | $ 350,000 |
Table: (4)
Compute the gross margin for Product Red:
Thus, the value of the gross margin for Product Red is $200,000.
Compute the gross margin for Product Yellow:
Thus, the value of the gross margin for Product Yellow is $300,000.
Compute the gross margin for Product Green:
Thus, the value of the gross margin for Product Green is $700,000.
Compute the gross profit for Product Red:
Thus, the value of gross profit for Product Red is ($228,571).
Compute the gross profit for Product Yellow:
Thus, the value of gross profit for Product Yellow is $85,714.
Compute the gross profit for Product Green:
Working note 1:
Compute the variable cost for Product Red:
Working note 2:
Compute the variable cost for Product Yellow:
Working note 3:
Compute the variable cost for Green:
Working note 4:
Compute the fixed manufacturing overhead for Product Red:
Working note 5:
Compute the fixed manufacturing overhead for Product Yellow:
Working note 6:
Compute the fixed manufacturing overhead for Product Green:
c.
Explain should the product Yellow be dropped or not for year 3.
Explanation of Solution
No, the product Yellow should not be dropped for Year 3. Product Red was dropped for the production for year 2. The total manufacturing overhead was reduced by $100,000. The implication of a reduction of $100,000 might seem favorable as well. Reduction in cost would directly result in more profit.
But, in the situation given, reduction in total manufacturing overhead by eliminating the product Red has reduced the gross profit and gross margin as well. Gross profit was declined to $483,333 from $592,857 resulting in an 18% decrease in gross profit.
For Year 1 the total cost, gross profit and gross margin for Products Red, Yellow and Green are as follow:
Particulars | Red | Yellow | Green | Total |
Total cost | $ 978,571 | $ 914,286 | $ 907,143 | $ 2,800,000 |
Gross profit | ($ 228,571) | $ 85,714 | $ 592,857 | $ 450,000 |
Gross margin | $ 200,000 | $ 300,000 | $ 700,000 | $ 1,200,000 |
Table: (5)
For Year 2 the total cost, gross profit and gross margin for Products Red, Yellow and Green are as follow:
Particulars | Yellow | Green | Total |
Total Cost | $ 1,133,333 | $ 1,016,667 | $ 2,150,000 |
Gross Profit | $ (133,333) | $ 483,333 | $ 350,000 |
Gross margin | $ 300,000 | $ 700,000 | $ 1,000,000 |
Table: (6)
Due to the elimination of product Red total gross profit has been reduced to $350,000. The reduction of $100,000 implies the reduction in cost as a whole. The total gross profit has declined by 18%.
But, to evaluate both the years separately the total impact on the cost and profit is negligible and there is a difference of 4% in gross margin with respect to total cost.
Hence, it is not advisable to drop the Product Yellow.
Want to see more full solutions like this?
Chapter 6 Solutions
FUNDAMENTALS OF...(LL)-W/ACCESS>CUSTOM<
- The advantages of calculating Contribution Margins of a company’s products seem to be overwhelming according to the author. One can quickly calculate their break-even point and evaluate pricing changes and product quality improvements. But after reviewing several annual reports, apparently, no one is using this technique. What’s missing in this analysis?arrow_forwardThe president of Poleski would like to know the effect that each of the following suggestions for improving performance would have on contribution margin per unit, sales needed to break even, and projected net income for next year. Each change should be considered independently. Reset the Data Section to its original values after each suggestion is analyzed. Fill in the table following the suggestions with the results of your analysis. a. The president suggests cutting the products price. Since the market is relatively sensitive to price, . . . a 10% cut in price ought to generate a 30% increase in sales (to 156,000 units). How can you lose? b. The sales manager feels that putting all sales personnel on straight commission would help. This would eliminate 77,000 in fixed sales salaries expense. Variable sales commissions would increase to 2.00 per unit. This move would also increase sales volume by 30%. c. Poleskis head of product engineering wants to redesign the package for the product. This will cut 1.00 per unit from direct materials and 0.50 per unit from direct labor, but will increase fixed factory overhead by 100,000 for additional depreciation on the new packaging machine. The package redesign would not affect sales volume. d. The firms consumer marketing manager suggests undertaking a new advertising campaign on Facebook. This would cost 30,000 more than is currently planned for advertising but would be expected to increase sales volume by 30%. e. The production superintendent suggests raising quality and raising price. This will increase direct materials by 1.00 per unit, direct labor by 0.50 per unit, and fixed factory overhead by 110,000. With improved quality, . . . raise the price to 18.50 and advertise the heck out of it. If you double your current planned advertising, Ill bet you can increase your sales volume by 30%.arrow_forwardTell what life-cycle cost management is and how it can be usedto maximize profits over a product's life cycle.Nico Parts, Inc., produces electronic products with short life cycles (of lessthan two years). Development has to be rapid, and the profitability of theproducts is tied strongly to the ability to find designs that will keep production and logistics costs low. Recently, management has also decided that postpurchase costs are important in design decisions. Last month, a proposal for a new product was presented to management. The total market was projected at 200,000 units (for the two-year period). The proposed selling price was $130 per unit. At this price, market share was expected to be 25 percent. The manufacturing and logistics costs were estimated to be $120 per unit. Upon reviewing the projected figures, Brian Metcalf, president of Nico, called in his chief design engineer, Mark Williams, and his marketing manager, CathyMcCourt. The following conversation was recorded:…arrow_forward
- Tell what life-cycle cost management is and how it can be usedto maximize profits over a product's life cycle.Nico Parts, Inc., produces electronic products with short life cycles (of lessthan two years). Development has to be rapid, and the profitability of theproducts is tied strongly to the ability to find designs that will keep production and logistics costs low. Recently, management has also decided that postpurchase costs are important in design decisions. Last month, a proposal for a new product was presented to management. The total market was projected at 200,000 units (for the two-year period). The proposed selling price was $130 per unit. At this price, market share was expected to be 25 percent. The manufacturing and logistics costs were estimated to be $120 per unit. Upon reviewing the projected figures, Brian Metcalf, president of Nico, called in his chief design engineer, Mark Williams, and his marketing manager, CathyMcCourt. The following conversation was recorded:…arrow_forwardUsing your answer to Requirement 1, assume that Reshier Company is considering dropping any model with a negative product margin. What are the alternatives? Which alternative is more cost effective and by how much? (Assume that any traceable fixed costs can be avoided.) Do NOT round interim calculations and, if required, round your answer to the nearest dollar. will add $fill in the blank 8723bbfe4004028_3 to operating income 3. What if Reshier Company can only avoid 182 hours of engineering time and 4,800 hours of setup time that are attributable to Model 1? How does that affect the alternatives presented in Requirement 2? Which alternative is more cost effective and by how much? Do NOT round interim calculations and, if required, round your answer to the nearest dollar. will add $fill in the blank 8723bbfe4004028_5 to operating incomearrow_forwardRockness asked, "Do you see any problems here? Should we drop any of these products? Should we reprice any of these products?" He said, "I am suspicious of these cost data, Rocky. Here we are assigning indirect costs to these products using a 260 percent rate. I really wonder whether that rate is accurate for all products. I want you to dig into the indirect cost data, figure out what drives those costs, and see whether you can give me more accurate cost numbers for these products." Rocky first learned from production that the process required four activities: (1) setting up production runs, (2) managing production runs, and (3) managing products. The fourth activity did not require labor; it was simply the operation of machinery. Next, he went to the accounting records to get a breakdown of indirect costs. Here is what he found: ---------------------------------------------------IMAGE 2----------------------------------------------------------------- Then, he began a series of…arrow_forward
- Integrative Cases 6-73 (Algo) Product Costing, Cost Estimation, and Decision Making (LO 6-1, 2) I don't understand this. Last year [year 1], we decided to drop our highest-end Red model and only produce the Yellow and Green models, because the cost system indicated we were losing money on Red. Now, looking at the preliminary numbers, our profit is actually lower than last year and it looks like Yellow has become a money loser, even though our prices, volumes, and direct costs are the same. Can someone please explain this to me and maybe help me decide what to do next year? Dolan Products is a small, family-owned audio component manufacturer. Several years ago, the company decided to concentrate on only three models, which were sold under many brand names to electronic retailers and mass-market discount stores. For internal purposes, the company uses the product names Red, Yellow, and Green to refer to the three components. Data on the three models and selected costs follow. Year 1…arrow_forwardIntegrative Cases 6-73 (Algo) Product Costing, Cost Estimation, and Decision Making (LO 6-1, 2) I don't understand this. Last year [year 1], we decided to drop our highest-end Red model and only produce the Yellow and Green models, because the cost system indicated we were losing money on Red. Now, looking at the preliminary numbers, our profit is actually lower than last year and it looks like Yellow has become a money loser, even though our prices, volumes, and direct costs are the same. Can someone please explain this to me and maybe help me decide what to do next year? Robert Dolan President & CEO Dolan Products Dolan Products is a small, family-owned audio component manufacturer. Several years ago, the company decided to concentrate on only three models, which were sold under many brand names to electronic retailers and mass-market discount stores. For internal purposes, the company uses the product names Red, Yellow, and Green to refer to the three components. Data on the three…arrow_forwardIn attempting to achieve better results in the marketplace, management has been looking at changing the reward system for marketing, distribution and sales personnel. This would result in an increase in variable marketing and administrative costs by $2 per unit, and would reduce fixed marketing and distribution costs by $100,000: Calculate the number of units required to breakeven if management implemented the changes and Would you suggest that management pursue the changes? Explain By reference to the above data:How can a company effectively use CPV (Cost-Volume-Profit) analysis to make strategic decisions about its product pricing and production levels?arrow_forward
- Barbour Corporation, located in Buffalo, New York, is a retailer of high-tech products and is known for its excellent quality and innovation. Recently, the firm conducted a relevant cost analysis of one of its product lines that has only two products, T-1 and T-2. The sales for T-2 are decreasing and the purchase costs are increasing. The firm might drop T-2 and sell only T-1. Barbour allocates fixed costs to products on the basis of sales revenue. When the president of Barbour saw the income statements (see below), he agreed that T-2 should be dropped. If T-2 is dropped, sales of T-1 are expected to increase by 10 percent next year, but the firm's cost structure will remain the same. Sales Variable costs: Cost of goods sold Selling & administrative Contribution margin es Fixed expenses: Fixed corporate costs Fixed selling and administrative Total fixed expenses Operating income Required: T-1 $ 200,000 70,000 20,000 $ 110,000 58,700 14,300 $ 73,000 T-2 $ 260,000 130,000 50,000 $ 80,000…arrow_forwardBarbour Corporation, located in Buffalo, New York, is a retailer of high-tech products and is known for its excellent quality and innovation. Recently, the firm conducted a relevant cost analysis of one of its product lines that has only two products, T-1 and T-2. The sales for T-2 are decreasing and the purchase costs are increasing. The firm might drop T-2 and sell only T-1. Barbour allocates fixed costs to products on the basis of sales revenue. When the president of Barbour saw the income statements (see below), he agreed that T-2 should be dropped. If T-2 is dropped, sales of T-1 are expected to increase by 10 percent next year, but the firm's cost structure will remain the same. Sales Variable costs: Cost of goods sold Selling & administrative Contribution margin Fixed expenses: Fixed corporate costs Fixed selling and administrative Total fixed expenses Operating income Required: T-1 $ 210,000 T-2 $ 268,000 72,000 22,500 $ 115,500 134,000 52,000 $ 82,000 77,000 23,000 62,000…arrow_forwardBarbour Corporation, located in Buffalo, New York, is a retailer of high-tech products and is known for its excellent quality and innovation. Recently, the firm conducted a relevant cost analysis of one of its product lines that has only two products, T-1 and T-2. The sales for T-2 are decreasing and the purchase costs are increasing. The firm might drop T-2 and sell only T-1. Barbour allocates fixed costs to products on the basis of sales revenue. When the president of Barbour saw the income statements (see below), he agreed that T-2 should be dropped. If T-2 is dropped, sales of T-1 are expected to increase by 10 percent next year, but the firm's cost structure will remain the same. Sales. Variable costs: Cost of goods sold Selling & administrative Contribution margin Fixed expenses: Fixed corporate costs Fixed selling and administrative Total fixed expenses Operating income T-1 $ 200,000 1. 2. Required % increase in sales from T-1 3. Required % increase in sales from T-1 70,000…arrow_forward
- Excel Applications for Accounting PrinciplesAccountingISBN:9781111581565Author:Gaylord N. SmithPublisher:Cengage Learning