Chapter 11, Problem 7F15

Cane Company manufactures two products called A1pia d Beta that sell for $120 and $80, respectively. Each product uses only one type of raw material that costs $6 per pound. The company has the capacity produce 10,0000 units of each product Its average cost per unit for each product at this level of activity are given below:

The company considers its traceable fixed manufacturing overhead to be avoidable, whereas its common fixed expenses are unavoidable and have been allocated to products based on sales dollars.
Required:
(Answer each question independently unless instructed otherwise.)
Assume that Cane normally produces and sells 40,000 Betas per year. What is the financial advantage (disadvantage) of discontinuing the Beta product line?

To determine

Concept Introduction:

Financial advantage (disadvantage): Financial advantage (disadvantage) refers to the incremental profit or loss, a company will earn in situations like acceptance of a special order, dropping of a business line, etc.

It is calculated by only considering the relevant costs. The incremental revenues and incremental costs are taken together to calculate financial advantage or disadvantage. Financial advantage refers to incremental net operating income and financial disadvantage refers to incremental net operating loss.

To calculate:

Financial advantage (disadvantage) of discounting Beta from operations.

Answer to Problem 7F15

Solution:

The financial advantage of discounting Beta from operations is $200,000 as Beta was earning - $ 200,000 as net operating loss considering all the relevant costs.

Explanation of Solution

The financial advantage (disadvantage) will be the net operating income lost due to discontinuance of Beta.

Note: The common fixed expenses are unavoidable, thus they are irrelevant costs here.

Net operating income (considering all the relevant costs) −

Net Operating Income from − Beta
Sales revenue ($ 80 per unit X 40,000 units)		3,200,000
Less: Variable expenses
Direct Material ($ 12 per unit X 40,000 units)	480,000
Direct Labor ($ 15 per unit X 40,000 units)	600,000
Variable manufacturing overhead ($ 5 per unit X 40,000 units)	200,000
Variable selling expenses ( $ 8 per unit X 40,000 units)	320,000
Total variable expenses		1,600,000
Less: Traceable fixed manufacturing overhead ( $ 18 per unit X 100,000 units)		18,00,000
Net Operating Loss from - Beta		(200,000)

Given, the information for the product Beta −

• Regular sales units = 40,000 units
• Selling price per unit = $ 80 per unit
• Direct Material per unit = $ 12 per unit
• Direct Labor per unit = $ 15 per unit
• Variable manufacturing overhead per unit = $ 5 per unit
• Variable selling expenses per unit = $ 8 per unit
• Traceable fixed manufacturing overhead = $ 18 per unit

Calculations:

1. Sales revenue

  $\begin{array}{l}Salesrevenue=\$\text{ 80 }perunitX\text{ 40},000units\hfill \\ Salesrevenue=\$\text{ 3,200},000\hfill \end{array}$

2. Total Variable expenses

  $\begin{array}{l}Directmaterial=\$\text{ 12 }perunitX\text{ 40},000units\hfill \\ Directmaterial=\$\text{ 48}0,000\hfill \end{array}$

  $\begin{array}{l}Directlabor=\$\text{ 15 }perunitX\text{ 40},000units\hfill \\ Directlabor=\$\text{ 600},000\hfill \end{array}$

  $\begin{array}{l}TotalVariablemanufacturingoverhead=\$\text{ 5 }perunitX\text{ 40},000units\hfill \\ TotalVariablemanufacturingoverhead=\$\text{ 200},000\hfill \end{array}$

  $\begin{array}{l}TotalVariablesellingexpenses=\$\text{ 8 }perunitX\text{ 40},000units\hfill \\ TotalVariablesellingexpenses=\$\text{ 32}0,000\hfill \end{array}$

  $\begin{array}{l}Total\text{ variable }\exp enses=Directmaterial+Directlabor+Variablemanufacturingoverhead\\ +Variablesellingexpenses\end{array}$

  $\begin{array}{l}Total\text{ variable }\exp ense=\$\text{ 480},000+\text{ 600},000+\$\text{ 200},000+\$\text{ 320},000\hfill \\ Total\text{ variable }\exp ense=\$\text{ 1,60}0,000\hfill \end{array}$

3. Total traceable fixed manufacturing overhead −

  $\begin{array}{l}Totaltraceablefixedmanufacturingoverhead=\$\text{ 18 }perunitX\text{ 100},000units\hfill \\ Totaltraceablefixedmanufacturingoverhead=\$\text{ 1,800},000\hfill \end{array}$

4. Net operating loss

  $\begin{array}{l}Netoperating\text{ Loss}=Salesrevenue–Totalvariableexpenses\\ -Totaltraceablefixedmanufacturingoverhead\\ Netoperating\text{ Loss}=\$3,200,000-\$1,600,000-\$\text{ 1,80}0,000\\ NetoperatingLoss=\text{ - }\$\text{ 200},000\end{array}$

Conclusion

Thus, the financial advantage of discounting Beta from operations is $ 200,000.

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