Management Accounting Project (15%) Group Three: Drop a product line: manufacturer Kitson Pty Ltd, a small manufacturing company, produces three types of air-conditioning units: Large, Small and Eco-friendly. For many years the company has been profitable and has operated at full capacity. However, for the last two years, prices on all air conditioners have been reduced and selling expenses increased to meet competition and to keep the plant operating at capacity. The following results for the second quarter typify recent experience:

Kitson Pty Ltd profit report second quarter (in $000s)

Large Small Eco-friendly Total Sales $1 600 $900 $900 $3 400 Cost of goods sold 1 048 770 950 2 768 Gross margin $552 $130 $ (50) $632 Selling and administrative expenses 370 185 135 690 Profit before taxes $182 $ (55) $(185) $(58) Kate Cameron, the companys managing director, is concerned about the results of the pricing, selling and production policies. After reviewing the second-quarter results, she asked her management staff to consider her proposed course of action, comprising the following three changes to operations: Discontinue the Eco-friendly line immediately. Eco-friendly would not be returned to the product line unless the problems with the product could be identified and resolved. Increase quarterly sales promotion by $100 000 on the Large product line in order to increase sales volume by 15 per cent. Cut production on the Small product line by 50 per cent, and cut the traceable advertising and promotion for this line to $20 000 each quarter. Bob Collins, the management accountant, suggested a more careful study of the financial relationships to determine the possible effects on the companys operating results of the managing directors proposed course of action. The managing director agreed and assigned Jenna Smith, the assistant accountant, to prepare an analysis. Smith has gathered the following information: The unit sales prices for the three air conditioners are as follows: Large $200 Small 90 Eco-friendly 180 The company is manufacturing at capacity and selling all it produces. All three air conditioners are manufactured with common equipment and facilities. The quarterly general selling and administrative expense is allocated to the three product lines in proportion to their dollar sales volume. Special selling expenses (primarily advertising, promotion and shipping) are incurred for each unit as follows: Quarterly advertising and promotion Shipping expense Large $210 000 $10 per unit Small 100 000 4 per unit Eco-friendly 4 000 10 per unit The unit manufacturing costs for the three products are as follows: Large Small Eco-friendly Raw material $ 31 $17 $ 50 Direct labour 40 20 60 Variable manufacturing overhead 45 30 60 Fixed manufacturing overhead 15 10 20 Total $131 $77 $190 Required: 1. Jenna Smith says that Kitsons product line profit report for the second quarter is not suitable for analysing proposals and making decisions such as the ones suggested by Kate Cameron. (a) Explain why the product line profit report, as presented, is not suitable for analysis and decision making. (b) Describe an alternative profit reporting format that would be more suitable for analysis and decision making, and explain why it is better than the original. 2. Construct an Excel spreadsheet using the operating data presented for Kitson and assume that the managing directors proposed course of action was implemented at the beginning of the second quarter. Then evaluate the managing directors proposal by specifically responding to the following points: (a) Is each of the three proposed changes cost effective? Support your discussion with an analysis that shows the net impact on profit before taxes for each of the three proposed changes. (b) Was the managing director correct in proposing that the Eco-friendly line be eliminated? Explain your answer. (c) Was the managing director correct in promoting the Large product line rather than the Small product line? Explain your answer. (d) Does the proposed course of action make effective use of Kitsons capacity? Explain your answer. 3. Are there any other issues that Kitsons management should consider before it drops the Eco-friendly line? Explain your answer.