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		5,000			10,000			20,000			35,000
Sales price per unit	$	150		$	100		$	75
Direct materials cost per unit	$	70		$	50		$	30
Direct labor-hours per unit		2			1			0.5
Wage rate per hour	$	20		$	20		$	20
Total manufacturing overhead										$	750,000

This year (year 2), the company only produced the Yellow and Green models. Total overhead was $650,000. 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 (loss) for year 1.

b. Compute the product costs and gross margins (revenue less cost of goods sold) for the two remaining products and total gross profit (loss) for year 2.

c. Should Dolan Products drop Yellow for year 3?

Answer 1

a. Compute the product costs and gross margins (revenue less cost of goods sold) for the three products and total gross profit (loss) for year 1.

	Red	Yellow	Green	Total
Product cost per unit	$160	$95	$52.50
Gross margin (loss) per unit	($10)	$5	$22.50
Total gross profit (loss)	($50000)	$50000	$450000	$450000

Product cost per unit = Direct Materials + (DLH * wage rate) + Manufacturing overhead

Red = $70 + (2 * $20) + [($750000/30000*10000)/5000] = $160

Yellow = $50 + (1 * $20) + [($750000/30000*10000)/10000] = $95

Green = $30 + (0.5 * $20) + [($750000/30000*10000)/20000] = $52.50

Gross margin (loss) per unit = Selling Price - Product cost per unit

Red = $150 - $160 = ($10)

Yellow = $100 - $95 = $5

Green = $75 - $52.50 = $22.50

b. Compute the product costs and gross margins (revenue less cost of goods sold) for the two remaining products and total gross profit (loss) for year 2.

	Yellow	Green	Total
Product cost per unit	$102.50	$56.25
Gross margin (loss) per unit	$2.50	$18.75
Total gross profit (loss)	$25000	$375000	$400000

Product cost per unit = Direct Materials + (DLH * wage rate) + Manufacturing overhead

Yellow = $50 + (1 * $20) + [($650000/20000*10000)/10000] = $102.50

Green = $30 + (0.5 * $20) + [($650000/20000*10000)/20000] = $56.25

Gross margin (loss) per unit = Selling Price - Product cost per unit

Yellow = $100 - $102.50 = ($2.50)

Green = $75 - $56.25 = $18.75

c. Should Dolan Products drop Yellow for year 3?

No