Dropping or Retaining a Product [LO2]

Tracey Douglas is the owner and managing director of Heritage Garden Furniture, Ltd., a South African company that makes museum-quality reproductions of antique outdoor furniture.

Ms. Douglas would like advice concerning the advisability of eliminating the model C3 lawnchair.

These lawnchairs have been among the company’s best-selling products, but they seem to be unprofitable.

A condensed absorption costing income statement for the company and for the model C3 lawnchair for the quarter ended June 30 follows:

All Products Model C3 Lawnchair Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . R2,900,000 R300,000 Cost of goods sold:
Direct materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 759,000 122,000 Direct labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 680,000 72,000 Fringe benefi ts (20% of direct labor) . . . . . . . . . . . . . . . . . . . . . . 136,000 14,400 Variable manufacturing overhead . . . . . . . . . . . . . . . . . . . . . . . . 28,000 3,600 Building rent and maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . 30,000 4,000 Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75,000 19,100 Total cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,708,000 235,100 Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,192,000 64,900 Selling and administrative expenses:
Product managers’ salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75,000 10,000 Sales commissions (5% of sales) . . . . . . . . . . . . . . . . . . . . . . . . 145,000 15,000 Fringe benefi ts (20% of salaries and commissions) . . . . . . . . . . 44,000 5,000 Shipping . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120,000 10,000 General administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . 464,000 48,000 Total selling and administrative expenses . . . . . . . . . . . . . . . . . . . 848,000 88,000 Net operating income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . R 344,000 R (23,100)
The currency in South Africa is the rand, denoted here by R.

The following additional data have been supplied by the company:

a. Direct labor is a variable cost.

b. All of the company’s products are manufactured in the same facility and use the same equipment.
Building rent and maintenance and depreciation are allocated to products using various bases. The equipment does not wear out through use; it eventually becomes obsolete.

c. There is ample capacity to fill all orders.

d. Dropping the model C3 lawnchair would have no effect on sales of other product lines.

e. Work in process and finished goods inventories are insignificant.

f. Shipping costs are traced directly to products.
g. General administrative expenses are allocated to products on the basis of sales. There would be no effect on the total general administrative expenses if the model C3 lawnchair were dropped.
h. If the model C3 lawnchair were dropped, the product manager would be laid off.
Required:
1. Given the current level of sales, would you recommend that the model C3 lawnchair be dropped? Prepare appropriate computations to support your answer.
2. What would sales of the model C3 lawnchair have to be, at minimum, in order to justify retaining the product? Explain. (Hint: Set this up as a break-even problem but include only the relevant costs.)