Axelrod Company makes three types of t-shirts: Calm, Windy, and Gale. Mr. Brown,

Question

Axelrod Company makes three types of t-shirts: Calm, Windy, and Gale. Mr. Brown, the general manager of the Company is disappointed with low sales and low profitability of Gale and is considering dropping the product. He believes that such a move will allow him to focus more attention to other profitable lines. He discusses this with you and asks for your opinion. You gather the following information about last year’s performance of the three products.

                                                                Calm                                      Windy                  Gale

Units Sold                                           25,000                                   18,750                   3,750

Selling Price/unit                             $ 30                                       $ 32                       $ 39

Production Cost:

Direct Materials/unit                     $ 10                                       $ 10                       $ 15

Direct Labor/unit                             $ 14                                       $ 14                       $ 21      

There is no variable overhead. Annual total fixed overhead amounts to $ 168,000 and will remain the same whether the product line is dropped or retained. The fixed overhead rate established by the company was $ 3.60 per unit. . The analysis provided to Mr. Brown on the basis of which he was considering to drop Gale from the line of products sold was as follows:

:

`                                                              Calm                                      Windy                  Gale

Selling Price/unit                             $ 30.00                                 $ 32.00                 $ 39.00

Direct Materials/unit                  ($ 10.00)                            ($ 10.00)            ($ 15.00)

Direct Labor/unit                          ($ 14.00)                            ($ 14.00)           ($ 21.00)              

Fixed Overhead/unit                  ($    3.60)                            ($    3.60)            ($    3.60)

                                                      --------------------------------------------------------------------------

Operating profit per unit              $ 2.40                                   $ 4.40                ($    0.60)

                                                                =========================================

Given the foregoing information, what advice will you give to Mr. Brown? Explain the conceptual reasoning behind your advice. Also provide numerical analysis to support your explanation.

Explanation / Answer

Income statement after dropping Gale:

Gale should be dropped. If Gale is dropped, the contribution margin of $ 11,250 from Gale will be lost, and overall income for the company gets reduced by $ 11,250. Rather, a more systematic approach to the allocation of fixed overheads is called for. As of now, it is too arbitrary.

Total Calm Windy Gale Sales revenue 1,496,250 750,000 600,000 146,250 Variable costs 1,185,000 600,000 450,000 135,000 Contribution margin 311,250 150,000 150,000 11,250 Total fixed costs 171,000 Income (loss) from operations 140,250

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