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 20 percent, it will be dropped. The margin is computed as product gross profit divided by reported product cost. Manufacturing overhead for year 1 totaled $800,000. Overhead is allocated to products based on direct labor cost. Data for year 1 show the following. Chairs Desks Sales revenue $ 1,150,000 $ 2,105,000 Direct materials 584,000 800,000 Direct labor 160,000 340,000

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?

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 $650,000. 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?

• Req A1
• Req A2
• Req B

Based on the CFO's new policy, calculate the profit margin for both chairs and desks.

	Profit Margin Chairs % Desks %

Which of the two products should be dropped?

	Chairsradio button unchecked1 of 2 Desksradio button unchecked2 of 2

	Estimated margin for desks - Year 2 %

Answer 1

Margin Calculation:	Gross Profit / Product Cost
Policy States:	Margin Less than 20% will be dropped
Alocation Method:	Direct Labour Hours
Requirment a - 1: Profit Margin
Particulars	Chair	Desks	Entity as a Whole
Sales Revenue	1150000	2105000	3255000
Less: Direct Material Cost	-584000	-800000	-1384000
Less: Direct Labour Cost	-160000	-340000	-500000
Less: Manufacturing Cost	-256000	-544000	-800000
Gross Profit	150000	421000	571000
Product Cost	1000000	1684000	2684000
Profit %	15%	25%	22%
Requirement a- 2: Product Dropping decision
Chair Shall be dropped due to gross Margin falls below the policy Mark up of 20%
Because as per the policy if it fall below 20%.
Hence , Chair shall be Dropped.
Requirement b:
Particulars	Desks	Entity as a Whole
Sales Revenue	2105000	2105000
Less: Direct Material Cost	-800000	-800000
Less: Direct Labour Cost	-340000	-340000
Less: Manufacturing Cost	-650000	-650000
Gross Profit	315000	315000
Product Cost	1684000	1684000
Profit %	19%	19%