Question

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. Tracey would like advice concerning the advisability of eliminating the model C3 lawn chair. These lawn chairs have been among the company’s best-selling products, but they seem unprofitable.

  A condensed statement of operating income for the company and for the model C3 lawn chair for the quarter ended June 30 follows:

  

		Model C3 Lawn Chair			All Products
Sales		R	1,300,000*		R	5,900,000
Cost of sales:
Direct materials			520,000			1,534,000
Direct labour			312,000			1,357,000
Fringe benefits (20% of direct labour)			62,400			271,400
Variable manufacturing overhead			15,600			59,000
Building rent and maintenance			16,900			59,000
Depreciation			83,200			147,500
Total cost of sales			1,010,100			3,427,900
Gross margin			289,900			2,472,100
Selling and administrative expenses:
Product managers’ salaries			42,900			147,500
Sales commissions (5% of sales)			65,000			295,000
Fringe benefits (20% of salaries and commissions)			21,580			88,500
Shipping			20,000			236,000
General administrative expenses			208,000			944,000
Total selling and administrative expenses			357,480			1,711,000
Net operating income (loss)		R	(67,580)		R	761,100

*The currency in South Africa is the rand, denoted here by R.

  

The following additional data have been supplied by the company:

a.	Direct labour is a variable cost at Heritage Garden Furniture.
b.	All of the company’s products are manufactured in the same facility and use the same equipment. Building rent, 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 lawn chair would have no effect on sales of other product lines.
e.	Inventories of work in process or finished goods are insignificant.
f.	Shipping costs are traced directly to products.
g.	General administrative expenses are allocated to products on the basis of sales dollars. There would be no effect on the total general administrative expenses if the model C3 lawn chair were dropped.
h.	If the model C3 lawn chair were dropped, the product manager would be laid off.

  

Required:

1-a.	At current level of sales, compute the effect of net operating income if the Model C3 lawn chair is dropped

1-b.

Would you recommend that the model C3 lawn chair be dropped?

	Yes
	No

2.	What would sales of the model C3 lawn chair have to be, at minimum, in order to justify retaining the product? (Hint: Set this up as a break-even problem, but include only the relevant costs from part (1).) (Round "Contribution margin ratio" to 2 decimal places and final answer to the nearest whole number.)

Answer 1

Ans1-a	Net Operating Income if Model C3 Lawn Chair is dropped
	Particulars	R	R
	Sales		5900000
	Direct Materials	1534000
	Direct Labour	1357000
	Fringe Benefits	271400
	Variable Manufacturing Overhead	59000
	Building Rent & Maint	75900		( Rent of Lawn chair will be added to all products)
	Depreciation	230700		( Depn of Lawn chair will be added to all products)
Less	Total Cost of Sales		3528000
	Gross Margin		2372000
	Selling & Admin Exps
	Product Manager Salaries	147500
	Sales Comission	295000
	Fringe Benefits	88500
	Shipping	236000
	General Admin Exps	944000
			1711000
	Net Operating Income		661000
Ans 1-b	The net income when model C3 produced is
	693520(761100-67580) and when the model C3 is
	dropped is 661000 hence it is better to produce
	same