Problem $9-2$ Deciding Whether to Add or Drop a Product $($LO$1-$ CC$3)($Algo$)$

Pam LaRose is the chief executive of Sturdy Furniture Inc. $($SFI$),$ which makes top$-$quality office furniture. LaRose would like advice concerning the advisability of eliminating the model A$1$ table. This table has been among the company$$s best$-$selling products, but it seems unprofitable.

A condensed statement of operating income for the company and for the model A$1$ table for the quarter ended September $30$ follows:

Model A$1$

table All Products

Sales $ $600,000*$ $ $3,800,000$

Cost of sales:

Direct materials $240,000988,000$

Direct labour $144,000874,000$

Fringe benefits $(20\%$ of direct labour$)28,800174,800$

Variable manufacturing overhead $7,20038,000$

Building rent and maintenance $7,80038,000$

Depreciation $38,40095,000$

Total cost of sales $466,2002,207,800$

Gross margin $133,8001,592,200$

Selling and administrative expenses:

Product managers$$ salaries $19,80095,000$

Sales commissions $(5\%$ of sales$)30,000190,000$

Fringe benefits $(20\%$ of salaries and commissions$)9,96057,000$

Shipping $13,000152,000$

General administrative expenses $96,000608,000$

Total selling and administrative expenses $168,7601,102,000$

Net operating income $($loss$)$ R $(34,960)$ R $490,200$

The following additional data have been supplied by the company:

Direct labour is a variable cost at SFI.

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.

There is ample capacity to fill all orders.

Dropping the model A$1$ table would have no effect on sales of other product lines.

Inventories of work in process or finished goods are insignificant.

Shipping costs are traced directly to products.

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 A$1$ table was dropped.

If the model A$1$ table was dropped, the product manager would be laid off.

Required:

a$-1.$ At current level of sales, compute the effect of net operating income if the Model A$1$ table is dropped.

$1-$b$.$ Would you recommend that the model A$1$ table be dropped?

multiple choice

Yes Incorrect

No

$2.$ What would sales of the model A$1$ table 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 Requirement $(1).$