Superior Manufacturing Company
The new president of Superior Manufacturing Company (SMC) has appointed Herbert Waters as general manager after the net loss of 2004 of $688,000. Water's first task was to decide whether to keep Product 103 or not. His decision to keep Product 103 based exclusively on the information in Exhibit 1 and Exhibit 2 seems to be a poor decision at first glance. This is due to the fact that almost all of the profits reported in Exhibit 2 for Product 101 are negated by Product 103. However, looking at Exhibit 1 makes us question whether Exhibit 2 is a fair representation of product performance since manufacturing profit is larger than operating expenses excluding interest. Water's experience has probably also given him insight into the fact that not all costs allocated to a product can be avoided by eliminating that product. There are a large number of costs that will not be able to be avoided such as the lease on the building that still has another 12 years of contract remaining.
Upon evaluating the possibility that Exhibit 2 has shed that certain costs are directly tied to the products and other costs are allocated based on volume sales, we have determined a new format to determine product shortcomings. In this format, direct costs are assigned for direct labor, power, and compensation expense at 5 % of direct labor, materials, supplies, and repairs. All of these direct costs are assigned because they are variable based on usage of the products and can be avoided if the products were eliminated. The remaining costs are considered indirect and cannot be avoided due to contracts, leases, or other circumstances that keeps the costs at a constant on a small range. 2004 product performance is as follows under this new format:
Profit and Loss forecast per product for January 1 to June 30, 2004
Segmented Margin Percentage
Common Indirect Overhead:
Light and Heat
Total Indirect Costs
Less: Other Income
Under this new format, we can see that each product is contributing a fair percentage of the contribution margin, between 52% for Product 103 to 57% for Product 101. We can now understand why Water's decided not to eliminate Product 103 since eliminating that product would result in worse loses than have already been reported in 2004.
One of SMC's competitors is reducing the price of Product 101 from $24.50 to $22.50 at the beginning of 2006. The calculated contribution margin of expected sales of 750,000 units at the continued price of $24.50 and expected sales of 1,000,000 at the reduced price of $22.50 follows.
SMC should follow suit of competition...
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