Making a decision to add or drop a product. The income statement for the McCartney Manufacturing Company is shown below. Management is concerned over the loss on Product Z.

Materials and labor are variable costs. Manufacturing overhead is applied at 50 percent of the direct labor cost. Variable overhead is 10 percent of the direct labor cost. Fixed overhead totals $11,600 per year. Variable operating expenses are 20 percent of the sales dollars. Fixed operating expenses total $18,000. The fixed overhead costs and operating expenses are expected to continue if Product Z is dropped.

Instructions 1. Prepare an income statement using direct costing to show the effects of retaining Product Z. You must first compute the variable manufacturing costs by product.
2. Prepare an income statement using direct costing to show the effects of dropping Product Z.
3. Explain what decision should be made and why.

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McCARTNEY MANUFACTURING COMPANY Income Statement (Absorption Costing) Year Ended December 31, 19X2 PRODUCT X PRODUCT Y PRODUCT Z TOTAL Sales $25,000 $90,000 $15,000 $130,000 Cost of Goods Sold Materials $ 3,000 $15,000 $ 2,000 $ 20,000 Labor 5,000 20,000 4,000 Manufacturing Overhead 2,500 10,000 2,000 29,000 14,500 Total $10,500 $45,000 $ 8,000 $ 63,500 Gross Margin on Sales $14,500 $45,000 $ 7,000 $ 66,500 Operating Expenses 10,000 25,000 9,000 44,000 Net Income or (Loss) $ 4,500 $20,000 $(2,000) $ 22,500