Chapter 9, Problem 72IC

a.

To determine

Ascertain the product cost and gross profit margin percentages of each product.

Explanation of Solution

Ascertain the product cost and gross profit margin percentages of each product.

Table (1)

Total rent for factory space:	$15,000 per month
Total machine operating costs:	$30,000 per month
Total other overhead:	$24,500 per month $\left(\$69,500-\$15,000-\$30,000\right)$
Total cases produced per month	3,000 cases

Table (2)

Product allocation base:

Fraction:	Labor (%)	Machine hours (%)	Factory Space (%)
Almond Dream	63.6%	13.3%	10%
Krispy Krackle	27.3	46.7	40
Creamy Crunch	9.1	40.0	50

Table (3)

Allocated costs:

Allocated costs:		Total	Per Case
Almond Dream $\left(\$24,500\times 63.6\%\right)+\left(\$30,000\times 13.3\%\right)+\left(\$15,000\times 10\%\right)$	=	$21,072	$21.07
Krispy Krackle $\left(\$24,500\times 63.6\%\right)+\left(\$30,000\times 13.3\%\right)+\left(\$15,000\times 10\%\right)$	=	26,699	26.70
Creamy Crunch $\left(\$24,500\times 63.6\%\right)+\left(\$30,000\times 13.3\%\right)+\left(\$15,000\times 10\%\right)$	=	21,730	21.73

Table (4)

Allocated Production Costs:

	Almond Dream	Krispy Krackle	Creamy Crunch
Material cost	$8.00	$2.00	$9.00
Direct labor	42.00	18.00	6.00
Allocated overhead	21.07	26.70	21.73
Production cost per case	$71.07	$46.70	$36.73
Selling price (b)	$85.00	$55.00	$35.00
Product cost	(71.07)	(46.70)	(36.73)
Profit (loss) (a)	$13.93	$8.30	$(1.73)
Profit margin ratio (c) = (a/b)	16.4%	15.1%	(4.9)%

Table (5)

Note (1):

Totals equal hours per case times 1,000 cases.

Hence, the product costs and gross profit margin percentage for the products Almond Dream, Krispy Krackle, and Creamy Crunch are $71.07, and 16.4%, $46.70, and 15.1%, and $36.73, and (4.9)%, respectively.

b.

To determine

Identify whether the management would recommend dropping any product.

Explanation of Solution

Identify whether the management would recommend dropping any product.

It would be recommended by the management to drop Creamy Crunch, based on the gross profit margin rule, and the table above. 50% of the factory space is used by the product Creamy Crunch, and so it is allocated half of the rent costs. When compared to the two products, the selling price is comparitively low. These are the two characteristics which make this product appear relatively unprofitable.

c.

To determine

Identify whether any of the remaining products should be dropped from the product line.

Explanation of Solution

Identify whether any of the remaining products should be dropped from the product line.

	Almond Dream		Krispy Krackle
Direct labor hours per case		7		3
Machine hours per case		2		7
Factory space (in sq.ft.) (1)	2,000	(33.3%)	4,000	(66.7%)
Case of output per month	2,000		1,000
Labour hours required	14,000	(82.4)	3,000	(17.6%)
Machine hours required	4,000	(36.4)	7,000	(63.6%)

Table (6)

Note (1):

4,000 square feet of space will be left available by this product mix.

Total rent for factory space:	$15,000 per month
Total machine operating costs:	$30,000 per month
Total other overhead:	$24,500 per month $\left(\$69,500-\$15,000-\$30,000\right)$
Total cases produced per month	3,000 cases
Total labor hours per month	17,000
Total machine hours	11,000 hours

Table (7)

Product allocation base:

Fraction:	Labor (%)	Machine hours (%)	Factory Space (%)
Almond Dream	82.4%	36.4%	33.3%
Krispy Krackle	17.6	63.6	66.7

Table (8)

Allocated costs:

Allocated costs:		Total	Per Case
Almond Dream $\left(\$24,500\times 82.4\%\right)+\left(\$30,000\times 36.4\%\right)+\left(\$15,000\times 33.3\%\right)$	=	$36,108	$18.05
Krispy Krackle $\left(\$24,500\times 17.6\%\right)+\left(\$30,000\times 63.6\%\right)+\left(\$15,000\times 66.7\%\right)$	=	33,392	33.39

Table (9)

Allocated Production Costs:

	Almond Dream	Krispy Krackle
Material cost	$8.00	$2.00
Direct labor	42.00	18.00
Allocated overhead	18.05	33.39
Production cost per case	$68.05	$53.39
Selling price (b)	$85.00	$55.00
Product cost	(68.05)	(53.39)
Profit (loss) (a)	$16.95	$1.61
Profit margin ratio (c) = (a/b)	19.9%	2.9%

Table (10)

The management should continue to produce Almond Dream, and should Drop Frispy Krackle, based on the gross profit margins of Krispy Krackle, and Almond Dream. The most profitable product is likely to be Almond Dream. However, its margin ratio is only 13.9%.

Calculate the margin ratio of Almond Dream:

	Almond Dream
Material cost	$8.00
Direct labor	42.00
Allocated overhead	23.17
Production cost per case	$73.17
Selling price (b)	$85.00
Product cost	(73.17)
Profit (loss) (a)	$11.83
Profit margin ratio (c) = (a/b)	13.9%

Table (11)

Almond Dream, and Krispy Krackle are found to be equally profitable, if the gross margin for the three products are computed at maximum production:

		Almond Dream	or	Krispy Krackle	or	Creamy Crunch
Cases		3,000		3,000		3,000
Costs
Materials		$ 24,000		$  6,000		$ 27,000
Labor		126,000		54,000		18,000
Overhead	+	69,500	+	69,500	+	69,500
		$219,500		$129,500		$114,500
Revenue		$255,000		$165,000		$105,000
Total costs	–	219,500	–	129,500	–	114,500
Gross margin		$ 35,500		$ 35,500		$ (9,500)

Table (12)

Hence, in decision making, too much of allocated cost numbers are not to be made.