Question

Congratulations, you are the Chief Executive Officer of Crown Can Company. Crown Can produces and sells three different types of cans: The Alpha version, the Gamma version, and the Beta version. A high-level, simplified profit/loss statement for your company is shown below. Corporate overhead (rent, general and administrative expense, etc.) is allocated equally among the three product versions. After reviewing the statement, your board of directors asks you which versions of cans should be continued or discontinued next year. Sales and costs are not expected to change in the future. What do you recommend to your board of directors and how do you explain your decision to the board?

	Alpha Cans	Gamma Cans	Beta Cans	Total
Can Sales	$     180,000	$      105,000	$    240,000	$     525,000
Variable Costs	$     105,000	$         82,500	$    250,000	$     322,500
Allocated Corporate Overhead	$       60,000	$         60,000	$      60,000	$     180,000
Net contribution to profit	$       15,000	$      (37,500)	$    (70,000)	$        22,500

Answer 1

Solution:

As per the information given in the question, Crown Can Company produces and sells three kinds of Cans namely Alpha, Gamma and Beta Cans. And it is also observed that the company is selling each type of can at different quantities. So, the variable costs will vary in proportion to the sales. and the corporate overheads should be allocated in the proportion of labour hours or machine hours but, due to non availability of information relating to labour/machine hours the corporate overheads can be allocated at overall overhead recovery rate with respect to sales.

In the profit/loss statement mentioned in the question, the following expenses are allocated incorectly namely,

1. Total Variable costs are $322,500 whereas the total amount allocated in the statement is $437,500.

2. Corporate overhead expenses are apportioned equally, which is not reasonable in this case.

Due to which the profit/ loss shown in the statement is not correct.

In order to find the correct profit/loss, the variable costs and corporate overheads should be allocated in proportion to sales at the rates mentined below:

1. Variable cost rate = Total Variable cost / Total Sales * 100

= $322500 / $525000 * 100

= 61.43%

2. Corporate Overhead allocation rate = Total Corporate Overheads / Total Sales * 100

= $180000 / $525000 * 100

= 34.29%

The correct profit/ loss statement can be prepared as follows :

(Amounts in $)

Reference	Particulars	Alpha Cans	Gamma Cans	Beta Cans	Total
a	Can Sales	180000.00	105000.00	240000.00	525000.00
b= a*61.43%	Variable Costs	110571.43	64500.00	147428.57	322500.00
c=a*34.29%	Allocated Corporate Overheads	61714.29	36000.00	82285.71	180000.00
d= a-b-c	Net contribution to Profit	7714.29	4500.00	10285.71	22500.00
Continue or Discontinue		Continue	Continue	Continue	Continue

Basing on the above profit or loss statement it can be observed that the company is earning a profit of $22500 as a whole in which Alpha, Gamma and Beta Cans are contributing a profit of $7714.29, $4500 and $10285.71 respectively.

Therefore, as Chief Executive Officer of Crown Can Company i will recommend the board of directors to continue the production of all the three types of Cans.

Notes:

1. It is assumed that the the variable cost ratio and corporate overheads allocation rate are same for all the three types of Cans.

2. Compuatated amounts are roundedoff to two decimal places.

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