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. Year 1 Red Yellow Green Total Units produced and sold 8,000 12,000 19,000 39,000 Sales price per unit $ 100 $ 70 $ 50 Direct materials cost per unit $ 40 $ 30 $ 15 Direct labor-hours per unit 2 1 0.4 Wage rate per hour $ 15 $ 15 $ 15 Total manufacturing overhead $712,000 This year (year 2), the company only produced the Yellow and Green models. Total overhead was $548,800. 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 (loss) 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 (loss) for year 2. c. Should Dolan Products drop Yellow for year 3?
Cost-Volume-Profit Analysis
Cost Volume Profit (CVP) analysis is a cost accounting method that analyses the effect of fluctuating cost and volume on the operating profit. Also known as break-even analysis, CVP determines the break-even point for varying volumes of sales and cost structures. This information helps the managers make economic decisions on a short-term basis. CVP analysis is based on many assumptions. Sales price, variable costs, and fixed costs per unit are assumed to be constant. The analysis also assumes that all units produced are sold and costs get impacted due to changes in activities. All costs incurred by the company like administrative, manufacturing, and selling costs are identified as either fixed or variable.
Marginal Costing
Marginal cost is defined as the change in the total cost which takes place when one additional unit of a product is manufactured. The marginal cost is influenced only by the variations which generally occur in the variable costs because the fixed costs remain the same irrespective of the output produced. The concept of marginal cost is used for product pricing when the customers want the lowest possible price for a certain number of orders. There is no accounting entry for marginal cost and it is only used by the management for taking effective decisions.
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.
| Year 1 | Red | Yellow | Green | Total | ||||||
| Units produced and sold | 8,000 | 12,000 | 19,000 | 39,000 | ||||||
| Sales price per unit | $ | 100 | $ | 70 | $ | 50 | ||||
| Direct materials cost per unit | $ | 40 | $ | 30 | $ | 15 | ||||
| Direct labor-hours per unit | 2 | 1 | 0.4 | |||||||
| Wage rate per hour | $ | 15 | $ | 15 | $ | 15 | ||||
| Total manufacturing |
$712,000 | |||||||||
This year (year 2), the company only produced the Yellow and Green models. Total overhead was $548,800. 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
b. Compute the product costs and gross margins (revenue less cost of goods sold) for the two remaining products and total gross profit (loss) for year 2.
c. Should Dolan Products drop Yellow for year 3?
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