Question

Neutron Co. manufactures and sells battery testers and solenoid testers for quick, easy use around the home. The following information related to these two products has been gathered from Neutron’s accounting records for the most recent year: Battery Tester Solenoid Tester Sales in units 20,000 10,000 Unit selling price $35 $20 Total unit cost $28 $22 Furthermore, the total unit cost of each product is calculated as follows: Battery Tester Solenoid Tester Fixed costs: Manufacturing $10 per unit $10 per unit Marketing & administrative $4 per unit $4 per unit Variable costs: Manufacturing $12 per unit $6 per unit Marketing & administrative $2 per unit $2 per unit Total $28 per unit $22 per unit Both fixed manufacturing and fixed marketing and administrative costs are assigned to products based on the number of units sold. That is, Neutron’s accountant takes the total fixed costs incurred and divides them by the total number of units sold to arrive at a fixed cost per unit. Moreover, Neutron expects to incur $420,000 in total fixed costs each year regardless of production volume. Because Neutron’s shop produced 30,000 total units in the most recent year, each product was assigned $420,000/30,000 = $14 per unit in fixed costs. Required a. What was Neutron’s overall profit for the most recent year? What was Neutron’s reported profit for each product? b. What was Neutron’s total contribution margin for the most recent year? What was Neutron’s contribution margin on each product? c. Since the unit cost of the solenoid tester exceeds the unit price, Neutron believes that the business would be more profitable if it stopped producing solenoid testers. Is this true? By how much will Neutron’s profit increase or decrease if the company stops producing and selling solenoid testers? d. Based on your answers to parts (a) through (c), what inferences do you draw about the value of expressing fixed costs as the amount allocated per unit rather than the total of the expenditure?

Answer 1

• All working forms part of the answer
• Working

	Battery Tester	Solenoid Tester
Units Sold	20000	10000
Selling Price per unit $	35	20
Variable Cost:
Manufacturing	12	6
Marketing & Administrative	2	2
Total variable cost per unit $	14	8
Contribution Margin per unit$	21	12

Fixed Cost
Manufacturing [10 x 30000 units]	300000
Marketing & Administrative [4 x 30000 units]	120000
Total fixed cost	420000

• Requirement 1

	Battery Tester	Solenoid Tester
SP per unit $	35	20
Total cost per unit $	28	22
Profit per unit $	7	(2)
Units	20000	10000
Overall profits /(loss) for each product $	140000	(20000)

Total Profit/(loss) = $140000 + ($20000) = $120000

• Requirement 2: Product wise contribution and total contribution

	Battery Tester	Solenoid Tester	Total
Units	20000	10000	30000
Contribution per unit $	21	12
Total contribution margin $	420000	120000	540000
(Less): Fixed Cost			420000
Overall profit $			120000

• Requirement 3: The management is not right. The product is in LOSS only because of Fixed cost. If variable costs have been more than selling price, the product could have been stopped. If the production of that product is stopped, the result would be as follows:

	Battery Tester	Solenoid Tester	Total
Units	20000	0	20000
Contribution per unit $	21	12
Total contribution margin $	420000	0	420000
(Less): Fixed Cost			420000
Overall profit $			0
Earlier profit $			120000
Decrease in profits $			120000

• Requirement 4:

Fixed costs should not be allocated or expressed as per unit for determining a PRODUCT’s profitability. Product profitability is to be measured on the basis of Contribution margin. Fixed Cost in total should be reduced from Over all contribution to calculated overall Profits or Losses.