Question

McNulty, Inc., produces desks and chairs. A new CFO has just been hired and announces a new policy that if a product cannot earn a margin of at least 15 percent, it will be dropped. The margin is computed as product gross profit divided by reported product cost. Manufacturing overhead for year 1 totaled $910,000. Overhead is allocated to products based on direct labor cost. Data for year 1 show the following: Chairs Desks Sales revenue $ 1,112,100 $ 2,570,400 Direct materials 603,000 990,000 Direct labor 170,000 480,000 Required: a-1. Based on the CFO's new policy, calculate the profit margin for both chairs and desks. a-2. Which of the two products should be dropped? Chairs Desks b. Regardless of your answer in requirement (a), the CFO decides at the beginning of year 2 to drop the chair product. The company cost analyst estimates that overhead without the chair line will be $840,000. The revenue and costs for desks are expected to be the same as last year. What is the estimated margin for desks in year 2? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 1 decimal place.)

Answer 1

a - 1

Manufacturing overhead = $910,000

Direct labor cost of Chairs = $170,000

Direct labor cost of Desks = $480,000

Total direct labor cost = $170,000 + 480,000

= $650,000

Manufacturing overhead applied to chairs = 910,000 x 170,000/650,000

= $238,000

Manufacturing overhead applied to desks = 910,000 x 480,000/650,000

= $672,000

	Chairs	Desks
Sales revenue (i)	1,112,100	2,570,400
Direct materials	603,000	990,000
Direct labor	170,000	480,000
Manufacturing overhead	238,000	672,000
Total cost (ii)	1,011,000	2,142,000
Gross profit	$101,100	$428,400

Profit margin on chairs = Gross profit/Total cost

= 101,100/1,011,000

= 10%

Profit margin on desks = Gross profit/Total cost

= 428,400/2,142,000

= 20%

a-2)

Chairs should be dropped since it has lower margin than required.

b)

	Desks
Sales revenue (i)	2,570,400
Direct materials	990,000
Direct labor	480,000
Manufacturing overhead	840,000
Total cost (ii)	2,310,000
Gross profit	$260,400

Profit margin on desks = Gross profit/Total cost

= 260,400/2,142,000

= 12.2%