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	6,000			11,000			21,000			38,000
Sales price per unit	$	160		$	130		$	60
Direct materials cost per unit	$	75		$	55		$	35
Direct labor-hours per unit		3			2			0.3
Wage rate per hour	$	13		$	13		$	13
Total manufacturing overhead										$833,400

This year (year 2), the company only produced the Yellow and Green models. Total overhead was $764,100. 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

Answer :

(a)

Calculation of product cost per unit, Gross margin (loss) per unit, Total gross profit (loss) :

Particulars	Red	Yellow	Green
Direct materials cost per unit	$75	$55	$35
Direct labor cost per unit	$39	$26	$3.90
	(3*13)	(2*13)	(0.30*13)
Manufacturing overhead per unit	$54	$36	$5.40
Product cost per unit	$168	$117	$44.30
Sales price per unit	$160	$130	$60
Gross margin (loss) per unit	-$8	$13	$15.70
No of units sold	$6,000	$11,000	$21,000
Total gross profit (loss)	-$48,000	$143,000	$329,700

So,

Particulars	Red	Yellow	Green	Total
Product cost per unit	$168	$117	$44.30	$329.30
Gross margin (loss) per unit	-$8	$13	$15.70	$20.70
Total gross profit (loss)	-$48,000	$143,000	$329,700	$424,700

Note : Calculation of Manufacturing Overhead per unit :

Total manufacturing overhead for year 1 = $833,400

Total Direct labor-hours for Red = 6,000 x 3 = 18,000

Total Direct labor-hours for Yellow = 11,000 x 2 = 22,000

Total Direct labor-hours for Green = 21,000 x 0.3 = 6,300

Total Direct labor-hours For year 1 = 18,000 + 22,000 + 6,300 = 46,300 hours

Manufacturing overhead allocation rate = $833,400 / 46,300 = $18 per hour

Manufacturing overhead for Red = 18,000 x 18 = $324,000

Manufacturing overhead for Yellow = 22,000 x 18 = $396,000

Manufacturing overhead for Green = 6,300 x 18 = $113,400

Particulars	Red	Yellow	Green
Total Manufacturing Overhead	324,000	396,000	113,400
Number of units produced and sold	6,000	11,000	21,000
Manufacturing Overhead per unit	54	36	5.40

(2)

Calculation of product cost per unit, Gross margin (loss) per unit, Total gross profit (loss) :

Particulars	Yellow	Green
Direct materials cost per unit	$55	$35
Direct labor cost per unit	$26	$3.90
	(2*13)	(0.30*13)
Manufacturing overhead per unit	$54	$8.10
Product cost per unit	$135	$47
Sales price per unit	$130	$60
Gross margin (loss) per unit	-$5	$13
No of units sold	$11,000	$21,000
Total gross profit (loss)	-$55,000	$273,000

So,

Particulars	Yellow	Green	Total
Product cost per unit	$135	$47	$182
Gross margin (loss) per unit	-$5	$13	$8
Total gross profit (loss)	-$55,000	$273,000	$218,000

Note : Calculation of Manufacturing Overhead per unit :

Total manufacturing overhead for year 2 = $764,100

Total Direct labor-hours for Yellow = 11,000 x 2 = 22,000

Total Direct labor-hours for Green = 21,000 x 0.3 = 6,300

Total Direct labor-hours For year 2 = 22,000 + 6.300 = 28,300 hours

Manufacturing overhead allocation rate = 764,100 / 28,300 = $27 per hour

Manufacturing overhead for Yellow = 22,000 x 27 = $594,000

Manufacturing overhead for Green = 6,300 x 27 = $170,100

Particulars	Yellow	Green
Total Manufacturing Overhead	594,000	170,100
Number of units produced and sold	11,000	21,000
Manufacturing Overhead per unit	54	8.10

(3) Although the product yellow had given per unit loss of $5 but it includes manufacturing overhead of $54 in its loss. Manufacturing overhead includes fixed costs as well which would continue to be incurred even if yellow is dropped and would be allocated to green product. So, this would decrease the profitability of company and green product.

So, No, Dolan Products should not drop Yellow for year 3.