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	7,000			11,000			18,000			36,000
Sales price per unit	$	155		$	125		$	100
Direct materials cost per unit	$	100		$	90		$	70
Direct labor-hours per unit		2			1			0.3
Wage rate per hour	$	14		$	14		$	14
Total manufacturing overhead										$577,600

This year (year 2), the company only produced the Yellow and Green models. Total overhead was $426,400. 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 (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	Product costs and gross margins for year 1
			Red	Yellow	Green	Total
	A	Units Manufactured and sold	7000	11000	18000
	B	Sales Price per unit	$155	$125	$100
	C=A*B	Sales Revenue	$1,085,000	$1,375,000	$1,800,000	$4,260,000
		Cost of goods sold:
	D	Direct materials cost per unit	$100	$90	$70
	E=A*D	Total Direct materials cost	$700,000	$990,000	$1,260,000	$2,950,000
	F	Direct labor hours per unit	2	1	0.3
	G=A*F	Total direct labor hours	14000	11000	5400	30,400
	H	Wage Rate per hour	$14	$14	$14
	I=G*H	Total Direct labor Cost	$196,000	$154,000	$75,600	425,600
	J	Manufacturing Overhead Rate(577600/30400)	$19.00	$19.00	$19.00
	K=G*J	Total manufacturing overhead cost	$266,000	$209,000	$102,600	$577,600
	L=E+I+K	Cost of goods sold	$1,162,000	$1,353,000	$1,438,200	$3,953,200
	M=C-L	Gross Margin	($77,000)	$22,000	$361,800	$306,800
		Total Gross Profit for year1	$306,800
	b
	a	Product costs and gross margins for year 2
			Yellow	Green	Total
	A	Units Manufactured and sold	11000	18000
	B	Sales Price per unit	$125	$100
	C=A*B	Sales Revenue	$1,375,000	$1,800,000	$3,175,000
		Cost of goods sold:
	D	Direct materials cost per unit	$90	$70
	E=A*D	Total Direct materials cost	$990,000	$1,260,000	$2,250,000
	F	Direct labor hours per unit	1	0.3
	G=A*F	Total direct labor hours	11,000	5,400	16,400
	H	Wage Rate per hour	$14	$14
	I=G*H	Total Direct labor Cost	$154,000	$75,600	$229,600
	J	Manufacturing Overhead Rate(426400/16400)	$26.00	$26.00
	K=G*J	Total manufacturing overhead cost	$286,000	$140,400	$426,400
	L=E+I+K	Cost of goods sold	$1,430,000	$1,476,000	$2,906,000
	M=C-L	Gross Margin	-$55,000	$324,000	$269,000
		Total Gross Profit for year1	$269,000
	c	Gross Margin of Yellow is negative
		Whether Yellow should be dropped or not depends upon reduction in overhead costs if yellow is dropped