6 Required information The Foundational 15 [LO12-2, LO12-3, L012-4, LO12-5, L012

ID: 2525200 • Letter: 6

Question

6 Required information The Foundational 15 [LO12-2, LO12-3, L012-4, LO12-5, L012-6] [The following information applies to the questions displayed below.] Part 6 of 15 Cane Company manufactures two products called Alpha and Beta that sell for $140 and $100, respectively. Each product uses only one type of raw material that costs $8 per pound. The company has the capacity to annually produce 106,000 units of each product. Its average cost per unit for each product at this level of activity are given below: points Alpha Beta $ 32 $16 19 Direct materials Direct labor Variable manufacturing overhead Traceable fixed manufacturing overhead Variable selling expenses Common fixed expenses Total cost per unit 24 10 20 16 19 $121 12 14 $92 The company considers its traceable fixed manufacturing overhead to be avoidable, whereas its common fixed expenses are unavoidable and have been allocated to products based on sales dollars. Foundational 12-6 6. Assume that Cane normally produces and sells 94,000 Betas per year. What is the financial advantage (disadvantage) of discontinuing the Beta product line? Answer is complete but not Financial disadvantage 1,692,00

Explanation / Answer

Solution:

Financial Advantage or (Disadvantage) from discontinuing a product line

This type of question has a direct relation with relevant cost.

Relevant Cost is the cost which will be incurred in future and different under each alternative course of action. The following costs are considered as relevant cost:

- Direct material cost

- Direct labor cost

- Variable manufacturing overhead

- Variable Cost of Goods Sold

- Variable selling and administrative expenses

- Fixed Cost which is directly related to the alternative course of action (traceable Fixed Cost).

The above costs are the variable cost which will vary with the production volume. Hence these costs have both the characteristic of relevant cost i.e. it is a future cost and different under each alternative course of action.

Sometimes there are some fixed costs which will directly associated with the production or increase production units and have characteristics of relevant cost. i.e. future cost and different under each alternative course of action.

Irrelevant cost is the costs which do not play any role in decision making. Irrelevant Cost is the SUNK Cost which has already been incurred and does not change whether company accept or reject the order. Hence it is treated as IRRELEVANT COST. In the given question the irrelevant cost is common fixed cost since it will continue to incur and does not have any affect from decision of continuing or discontinuing a product line.

Calculation of Financial Advantage (Disadvantage) from discontinuing Beta Product Line

BETA

Unit Selling Price of Beta Unit

$100

Total Variable Relevant Cost per unit:

Direct Materials cost pe runit

$16

Direct labor per unit

$19

Variable Manufacturing Overhead per unit

Variable Selling expenses per unit

$12

Total Relevant Variable Cost per unit

$56

Contribution Margin Lost per unit (Selling price - Variable relevant cost)

$44

Annual Number of Units of Beta Sell

94,000 Units

Total Contribution Margin lost by discontinuing Beta line

(94,000 Units x $44)

$4,136,000

Less: Saving in Traceable Fixed Cost

(106,000 Units x $22)

-$2,332,000

Net Financial Disadvantage

$1,804,000

Note – We should know why we have taken 106,000 Units in calculating the traceable fixed cost. Question says that the capacity of the company to produce and sell each product is 106,000 Units and the average cost per unit for each product at this level (this level means 106,000 Units) is given.

Since fixed cost does not change with the change in activity level, the total fixed traceable cost = 106,000 Units x 22 = $2,332,000

Financial (Disadvantage) = $1,804,000 or this amount can be mentioned with negative sign if question says.