Question

Cool Rays Ltd. is considering dropping its Tinted Glass product line. The Tinted Lens product line income statement for the last year was as follows:

sales		1,850,000
Cost of goods sold
variable manufacturing portion	1,080,000
fixed manufacturing portion	720,000	1,800,000
gross profit		50,000
selling and administration
comissions (10% based on sales)	185,000
advertising for tinted glass line	115,000
allocated head office expenses	45,000	345,000
operating loss		-295,000

The company has a total of 3 product lines. Only $200,000 of fixed manufacturing costs can be eliminated if the Tinted Lens product line is discontinued.   The balance of the fixed manufactured costs have been allocated to the product line on the basis of sales.  

Should Cool Rays drop the Tinted Glass product line? By how much would operating income increase or decrease if the product line is dropped? Show your work.

Irrespective of your calculation above, very briefly list two other considerations that should influence senior management’s decision in decisions of this type?

Regardless of your answer above, assume the company would lose $200,000 if the Tinted Lens product line were dropped. Also assume that if the Tinted Glass product line was dropped the company could introduce a new product line Z, which is quite unique in the market place. The following information relates to this possibility:

Sales of product line Z                                    $1,000,000

Variable manufacturing costs                          50% of selling price

Sales commissions                                         10% of selling price

Required advertising for product line Z           $75,000

The amount allocated to product line Z for fixed manufacturing expenses and head office expenses would remain the same.

Required: Should the company drop the Tinted Lens product line and introduce the new product line Z? (There is insufficient capacity to sell both product lines.) By how much will operating income increase or decrease if the company discontinues the Tinted glass product line and introduces Z? Show your work.

Answer 1

Cool Rays should not drop the Tinted Glass Product Line. By dropping the Product line there would be decrease in operating profits by $270000.

The management should refrain from dropping a product line if the Sales minus variable costs is positive which implies that the product line is able to cover part of the fixed costs which the organization has to bear irrespective of the product line existing or not. Also, while considering the decision to continue a product, the allocated costs pertaining to the entire organisation should not be considered as they would be incurred irrespective of the existence of the product.

If there is insufficient capacity to sell both the product lines, the company should go ahead with product Z as it would generate a profit of $325000 ignoring both the allocated manufacting and office expenses and discontinuing the Tinted Glass line would lead to a loss of $200000, thereby Z would generate an extra income of $125000.