Question

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	9,000			14,000			24,000			47,000
Sales price per unit	$	165		$	107		$	75
Direct materials cost per unit	$	90		$	70		$	50
Direct labor-hours per unit		3			1			0.3
Wage rate per hour	$	11		$	11		$	11
Total manufacturing overhead										$771,200

This year (year 2), the company only produced the Yellow and Green models. Total overhead was $625,400. 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. (Do not round intermediate calculations. Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places.)

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. (Do not round intermediate calculations. Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places.)
     

c. Should Dolan Products drop Yellow for year 3?   

	Yes
	No

Answer 1

Part a
		Red	Yellow	Green	Total
	Units Produced	9000	14000	24000
	Direct labor hours per unit	3	1	0.3
	Total Direct labor hours	27000	14000	7200	48200 hours
	Manufacturing overhead				$                             7,71,200
	Manufacturing overhead rate($771,200/48,200)				$                                       16	per hour
	Computation of Products Costs and Gross Margin for Year 1
		Red	Yellow	Green	Total
	Units Produced	9000	14000	24000	47000
	Direct materials Costs per unit	90	70	50
	Direct labor cost per unit(Direct labor hours*Wage rate per hour)	33	11	3.3
	Manufacturing overhead per unit(Wage rate per hour*Manufacturing overhead rate)	$                                                48	$                                       16	$                                    5
	Total Unit Product costs	$                                         171.00	$                                  97.00	$                             58.10
	Sales Price per unit	$                                         165.00	$                                107.00	$                             75.00
	Less:Unit product costs	$                                         171.00	$                                  97.00	$                             58.10
	Gross Margin per unit	$                                            -6.00	$                                  10.00	$                             16.90
	Total Sales	$                                    14,85,000	$                           14,98,000	$                      18,00,000	$                           47,83,000
	Total Product Costs	$                                    15,39,000	$                           13,58,000	$                      13,94,400	$                           42,91,400
	Total Gross Margin	$                                        -54,000	$                             1,40,000	$                        4,05,600	$                             4,91,600
Part b
		Yellow	Green	Total
	Units Produced	14000	24000	38000
	Direct labor hours per unit	1	0.3
	Total Direct labor hours	14000	7200	21200 hours
	Manufacturing overhead			$                        6,25,400
	Manufacturing overhead rate($771,200/48,200)			$                             29.50	per hour
	Computation of Products Costs and Gross Margin for Year 2
		Yellow	Green	Total
	Units Produced	14000	24000	47000
	Direct materials Costs per unit	70	50
	Direct labor cost per unit(Direct labor hours*Wage rate per hour)	11	3.3
	Manufacturing overhead per unit(Wage rate per hour*Manufacturing overhead rate)	$                                                30	$                                         9
	Total Unit Product costs	$                                         110.50	$                                  62.15
	Sales Price per unit	$                                         107.00	$                                  75.00
	Less:Unit product costs	$                                         110.50	$                                  62.15
	Gross Margin per unit	$                                            -3.50	$                                  12.85
	Total Sales	$                                    14,98,000	$                           18,00,000	$                      32,98,000
	Total Product Costs	$                                    15,47,000	$                           14,91,600	$                      30,38,600
	Total Gross Margin	$                                        -49,000	$                             3,08,400	$                        2,59,400

c. Dolan Products not drop Yellow for year 3. Because the entire overhead has to be absorbed by Green only.

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