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Problems on Drop or Continue Product Line Decision P– 1. A business trading on stationery is thinking of dropping the ink section, which is showing a confines loss for the last few months. Following is its monthly income statements. Particulars Sections Pen Ink Notecopies Sales Rs. 8,000 Rs. 16,000 Rs. 24,000 Variable costs 4,000 12,000 16,000 Contribution margin 4,000 4,000 8,000 Fixed cost : Separable 1,000 2,000 2,000 Non– separable 2,000 4,000 4,000 Total 3,000 6,000 6,000 Net Income 1,000 (2,000) 2,000 If Ink department is dropped, the vacated space can be rented at Rs.125 per month of which Rs.25 is maintenance cost. Do you agree for dropping Ink department? P – 2. The Regal Cycle Company manufactures three types of bicycles – a dirt bike, a 10 speed bike, and a touring bike. Data on sales and expenses for the past six months follow: Particulars Total Dirt bikes 10–speed Touring bikes bikes Sales $ 300,000 $ 90,000 $ 150,000 $ 60,000 Less: Variable expenses 120,000 27,000 60,000 33,000 Contribution margin 180,000 63,000 90,000 27,000 Less: Fixed expenses: Advertising, direct 30,000 10,000 14,000 6,000 Depreciation of special equipment 23,000 6,000 9,000 8,000 Salary of line supervisor 35,000 12,000 13,000 10,000 Common, but allocated* 60,000 18,000 30,000 12,000 Total fixed expenses 148,000 46,000 66,000 36,000 Net income (loss) $ 32,000 $ 17,000 $ 24,000 $ (9,000) * Allocated on a basis of sales dollars Management is concerned about the continued losses shown by the touring bikes and wants a recommendation as to whether or not the line should be discontinued. The special equipment used to produce touring bikes has no resale value. Required: Should production and sale of the touring bikes be discontinued? Show computations to support your answer. P – 3. You have been engaged to assist the management of the Arcadia Corporation in arriving at certain decisions. Arcadia has its home office in Ohio and leases factory buildings in Texas, Montana, and Maine, all of which produce the same product. The management of Arcadia has provided you with a projection of operations for 19x7, the forthcoming year, as follows: Particulars Total Texas Montana Maine Sales $ 4,400,000 $ 2,200,000 $ 1,400,000 $ 800,000 Fixed costs: Factory 1,100,000 560,000 280,000 260,000 Administration 350,000 210,000 110,000 30,000 Variable costs 1,450,000 665,000 425,000 360,000 1 Allocated home office costs Total Net profit from operations 500,000 3,400,000 1,000,000 225,000 1,660,000 540,000 175,000 990,000 410,000 100,000 750,000 50,000 The sales price per unit is $25. Due to the marginal results of operations of the factory in Maine, Arcadia has decided to cease operations and sell that factory’s machinery and equipment by the end of 19x6. Arcadia expects that the proceeds from the sale of these assets would be greater than their book value and would cover all termination costs. Arcadia, however, would like to continue serving its customers in that area if it is economically feasible and is considering one of the following three alternatives: a. Expand the operations of the Montana factory by using space presently idle. This move would result in the following changes in that factory’s operations: Particulars Increase Over factory’s current operations Sales 50% Fixed costs: Factory 20% Administration 10% Under this proposal variable costs would be $8 per unit sold. b. Enter into a long–term contract with a competitor who will serve that area’s customers. This competitor would pay Arcadia a royalty of $4 per unit based upon an estimate of 30,000 units being sold. c. Close the Maine factory and not expand the operations of the Montana factory. Note: Total home office costs of $550,000 will remain the same under each situation. Required: In order to assist the management of Arcadia Corporation in determining which alternative is more economically feasible, prepare a schedule computing Arcadia’s estimated net profit from total operations that would result from each of the following methods: a. Expansion of the Montana factory. b. Negotiation of long–term contracts on a royalty basis. c. Shutdown of Maine operations with no expansion at other locations. (AICPA adapted) P – 4. The Croteau Food Company has two divisions: the Tea Divisions and the Crumpets Division. The divisional income statement for the year ended December 31, 19x1, follows (in thousands): Particulars Tea Crumpets Total Sales $ 5,000 $ 1,000 $ 6,000 Costs: Direct material $ 2,000 $ 200 $ 2,200 Direct labour 500 90 590 Variable overhead 400 70 470 Fixed overhead 750 500 1,250 Variable selling and administrative 100 40 140 Fixed selling and administrative 400 200 600 Total costs $ 4,150 $ 1,100 $ 5,250 Net income $ 850 ($ 100) $ 750 The two divisions are housed in a single facility; and if management should decide to curtail or drop one or the other activity, it is doubtful that total capacity would be reduced. The selling price for tea is $2.50 per case; for crumpets, $1 per case. 2 Required: a. Revise the form of the income statement to make it more meaningful for the purpose of appraising divisional profitability. b. Compute break–even points for (1) tea; (2) crumpets; and (3) the total company. c. Should the company drop crumpets? Why? d. Comment on other factor which might influence your decision in this case. P – 5. A discount department has three major departments: Groceries, General Merchandise and Drugs. The department is thinking of dropping the Groceries departments which has constantly shown a net loss. The present annual net income of the store is as follows: (in Thousands) Particulars Groceries General Drugs Total Merchandise Sales $. 1,000 $. 800 $. 100 $. 1,900 Variable costs 800 560 60 1,420 Contribution margin 200 240 40 480 Fixed costs: Separable 150 100 15 265 Joint but allocated 60 100 20 180 Total fixed cost 210 200 35 445 Net income (loss) (10) 40 5 35 Required: 1. Which alternative would you recommend either to drop or continue the grocery department? Assume that the total assets invested will not be affected by decision. Also assume that the vacated space will be idle. 2. Should the groceries department be closed under the condition that the space made available by the dropping of groceries would be used by an expanded G. Merchandise Department? The sales will be increase by $ 500, generates a 30% contribution margin and have separable fixed costs of $ 70 by doing it. P – 6. The officers of Bradshaw Company are reviewing the profitability of the company’s four products and the potential effect of several proposals for varying the product mix. An excerpt from the income statement and other data follow: Product Particulars Total P Q R S Sales $ 62,600 $ 10,000 $ 18,000 $ 12,600 $ 22,000 Cost of goods sold 44,247 4,750 7,056 13,968 18,500 Gross profit 18,326 5,250 10,944 (1,368) 3,500 Operating expenses 12,012 1,990 2,976 2,826 4,220 Income before income taxes 6,314 3,260 7,968 (4,194) (720) Units sold 1,000 1,200 1,800 2,000 Sales price per unit 10.00 15.00 7.00 11.00 Per unit Variable cost of goods sold 2.50 3.00 6.50 6.00 Per unit Variable operating 1.17 1.25 1.00 1.20 expenses per unit Each of the following proposals is to be considered independently of the other proposals. Consider only the product changes stated in each proposal; the activity of other products remains stable. (Ignore income taxes) Required: 3 a. If product R is discontinued, what will be the effect on income? b. If product R is discontinued and a consequent loss of customers causes a decrease of 200 units in sales of Q, what will be the total effect on income? c. If the sales price of R is increased to $8 with a decrease in the number of units sold to 1,500, what will be the effect on income? d. The plant in which R is produced can be utilized to produce a new product T. The total variable costs and expenses per unit of T are $8.05, and 1,600 units can be sold at $9.50 each. If T is introduced and R is discontinued, what will be the total effect on income? e. Part of the plant in which P is produced can easily be adapted to the production of S, but changes in quantities may make changes in sales price advisable. If production of P is reduced to 500 units (to be sold at $12 each) and production of S is increased to 2,500 units (to be sold at $10.50 each), what will be the total effect on income? f. Production of P can be doubled by adding a second shift, but higher wages must be paid, increasing variable cost of goods sold to $3.50 for each of the additional units. If the 1,000 additional units of P can be sold at $10 each, what will be the total effect on income? P–7 PRINGLES DEPARTMENTAL STORE Income Statement Under Variable Costing For the quarter ending march 19x5 A B C $ 280,000 $ 700,000 $ 520,000 156,000 435600 312,000 124,000 264,400 208,000 Particulars Sales Less: Variable expense Contribution margin Less: Fixed expenses: Direct advertising General advertising Salaries Rent on building Utilities Employment taxes Depreciation on fixtures Insurance on inventory and fixtures General office expenses Service department expenses Total fixed cost Net income (Loss) 26,000 5,600 36,000 19,000 8,000 5,400 10,800 1,200 20,000 15,000 147,000 (23,000) 40,000 14,000 58,000 31,500 13,600 8,700 16,300 1,400 20,000 15,000 218,500 45,900 31,500 10,400 42,000 26,000 9,300 6,300 12,900 1,100 20,000 15,000 174,500 33,500 Total $ 1,500,000 903600 596,400 97,500 30,000 136,000 76,500 30,900 20,400 40,000 3,700 60,000 45,000 540,000 56,400 Note: General expenses, rent on building and employment taxes are allocated based on sales dollars, space occupied and salaries paid directly in each department. You has been assigned task of making a recommendation to the president as to whether or not department-A should be eliminated. You have gathered the following information. a. All departments are housed in the same building. The store leases the entire building at a fixed annual rental rate. b. One of the employees in department A is Mary Collins, who has been with the company for many years. If department A is eliminated she will be transferred to another departments. Her salary is $4,000 per quarter. 4 c. If department A is eliminated, the fixtures in the department will be transferred to another departments. d. If department A is eliminated, the utilities will be reduced by about $7,000 per quarter. e. One fourth of the insurance in department A relates to the fixtures in the department, the remainder relates to the department’s merchandise inventory. f. The company has two service departments– purchasing and warehouse. If department A is eliminated, the company can discharge one fulltime and one part time person from these departments. The combined salaries and other employment costs of these employees is $ 5,300 per quarter. General office expenses will not change. Required: 1. Assume that the company has no alternative use for the space now being occupied by the department. Give your advice whether or not to department should be dropped? 2. Assume that the space being occupied by department A is valuable and could be sub leased at a rental rate of Rs. 60,000 per quarter. Would you advice the company to eliminate department A and sublease the space? Show computation. P – 8. The management of a company is considering the proposal to discontinue the manufacturing of product X from out of the list of its product X, Y and Z the details of which given below: X Y Z Capacity in actual production 20% 40% 40% Units manufactured 4,000 10,000 12,000 Cost per unit: Material Rs. 25 Rs 20 Rs 40 Labour 15 10 20 Fixed overhead 4 4 5 Variable overhead 4 3 5 48 37 70 Profit (Loss) per unit (4) 13 10 Selling price per unit 44 50 80 It is intended to utilize the disengaged capacity of X in Y and Z equally. Expected rise in price and costs are as follows: Particulars Y Z Material 5% 5% Labour 10% 10% Selling 10% 5% You are required to prepare a statement of projected profitability with suggestion for adopting the scheme. P –9. The Bottlers Nepal Ltd. a producer of soft drink, produces three standard products called Coke, Fanta and Soda. The results of the operation for the last year ending on 30th Chaitra are presented below in an income statement. Particulars Coke Fanta Soda Total Number of bottles sold 10,000 10,000 5,000 25,000 Sales Revenue (Rs.) 2,00,000 2,00,000 1,00,000 5,00,000 Less: Cost of production: Direct Material 40,000 40,000 20,000 1,00,000 Direct Labour 40,000 40,000 20,000 1,00,000 5 Manufacturing overheads: Variable overhead Fixed overhead Total cost of production Gross Margin available Less: Other costs: Variable selling & Adm. cost Fixed selling & Adm. cost Total Net income before tax 20,000 40,000 1,40,000 60,000 20,000 40,000 1,40,000 60,000 10,000 30,000 80,000 20,000 50,000 1,10,000 3,60,000 1,40,000 10,000 20,000 30,000 30,000 10,000 20,000 30,000 30,000 5,000 20,000 25,000 (5,000) 25,000 60,000 85,000 55,000 The result of operation shows product Soda has suffered losses for years. Therefore, the management is considering to drop out Soda from its production schedule. If it does so it will be able to avoid all variable costs associated with the product Soda and will be able to reduce its fixed manufacturing overhead cost by Rs. 10,000 as depreciation cost of specialized machine. All other fixed costs are allocated fixed cost will remain there irrespective of decision, but the company will lose its sales of other products by 5%. Required: Should the company drop out Soda? (TU 2052) P – 10. The income statement of a multi-product company has been given below: Particulars A B C Total Capacity utilization 40% 30% 30% 100% Units produced & sold 5,000 4,000 4,000 13,000 Sales revenue Rs. 400,000 Rs. 240,000 Rs. 200,000 Rs. 840,000 Less variable cost 200,000 80,000 160,000 440,000 Contribution margin 200,000 160,000 40,000 400,000 Less fixed cost: Joint fixed cost 80,000 60,000 60,000 200,000 Department fixed cost 40,000 30,000 30,000 100,000 Total fixed cost 120,000 90,000 90,000 300,000 Net income/B.T. 80,000 70,000 (50,000) 100,000 Seeing the state of product C the company has been considering to drop the product and take the following alternatives: i) To drop product C and keep capacity un-utilized and avoid departmental fixed cost by cent percent. ii) To transfer the available capacity to produce product A, and the result will be increased in production of A by 2,000 units and increase in department fixed cost by Rs. 40,000. iii) To transfer the available capacity of C product to produce product B. The result will be increased in production volume by 100%, and an increase of variable cost for additional product by Rs.10 per unit over and above the regular V cost and increase in departmental fixed cost by Rs.20,000. Required: a. Should the company drop product C if alternative II & III are not available. b. Which of the other two alternatives the company should choose and why? (TU 2054) P –111 Electronic Co. Ltd manufactures Tube, Television and Refrigerator in three different autonomous departments. The income statement regarding such products are given below. 6 Income Statement of Electronic Co. Ltd For the year ending 2005 Particulars Tube Television Refrigerator Total Sales units 10,000 1,500 2,000 13,500 Sales Revenue 200,000 450,000 800,000 1450,00 Less: Variable Cost 100,000 200,000 500,000 800,000 Gross Profit 100,000 250,000 300,000 650,000 Less: Departmental 20,000 100,000 200,000 320,000 fixed cost Joint fixed cost 30,000 50,000 120,000 200,000 Net Income 50,000 100,000 (20,000) 130,000 The refrigerator division bas suffered losses for years. The management is considering to drop out Refrigerator from its production schedule. If it is dropped, the capacity of the company cannot be changed. Required 1. Should the refrigerator division be dropped? Give you decision with necessary calculations. 2. The output of the tube division is the input of the television division. What price should the tube division charge for its product to the television division if (i) the tube division has excess capacity (ii) It has no excess capacity. P –121Buddha Enterprises runs two retail shops: Book Stall and Stationery. Monthly income data of Buddha Enterprises are presented in the following table for December 2006. Book Stall Sales Less: Variable Expenses Contribution Margin Less: Fixed Cost Operating Income (Loss) Stationary Total Rs. 240,000 96,000 Rs.360,000 252,000 Rs.600,000 348,000 144,000 60,000 108,000 120,000 252,000 180,000 84,000 (12,000) 72,000 Additional information: Buddha estimates that closing the stationery would result in a 10 % decrease in Book store sales, while closing the Book store would not affect stationery store’s sales. One- fourth of each store’s fixed expenses would continue through January 1, 2007, if either stores were closed. The operating results for December 2006 are representative of all months. Required: a. Calculate Buddha’s breakeven sales volume as on Dec.2006. b. Calculate the increase or decrease in Buddha’s monthly operating income during 2007, if the stationery store is closed. c. Buddha is considering a promotional campaign at the stationery store that would not affect the Book stall. Monthly promotion expenses at the stationery store that would be increased by Rs. 15000 in order to increase its sales by 10 %. What would be the effect of this promotional program on the Buddha’s monthly operating income during 2007? [PU 2007] 7 8