Gloria Climaco, chairwoman of Panorama Industrial Corporation, had just completed examining a projected profit summary for two components that would be used in LCD Screens. Both units were still in a very preliminary planning stage, and a decision had to be made regarding their continued viability. The components would be developed, produced, and sold at the same time. Each product's life cycle is 40 months. The projected profit performance of the two items promised a return on sales of 10 percent - less than the 14 percent rate set by company standards. From the statements below, it appeared to Gloria that the culprit was Component AB8 because its gross profit percentage was much lower than that of Component AA5.

 

Required:
 

a) Explain why Eva may be wrong in her assessment of the relative performances of the two products. What changed in the company's life-cycle budgeting approach would you suggest?

 

b)  Suppose that 75 percent of the research and development and 75 percent of the selling expenses are traceable to Component AA5. Prepare budgeted life-cycle income statements for each product and calculate the return on sales. What does this tell you about the importance of accurate life-cycle budgeting

 

Sales Cost of goods sold Gross profit Research and development Selling expenses Profit before taxes AA5 P500,000 250,000 P250,000 AB8 P500,000 350,000 P150,000 Total P1,000,000 600,000 P 400,000 (230,000) (70,000) P 100,000