Question

McNulty, Inc., produces desks and chairs. A new CFO has just been hired and announces a new policy that if a product cannot earn a margin of at least 20 percent, it will be dropped. The margin is computed as product gross profit divided by reported product cost. Manufacturing overhead for year 1 totaled $645,000. Overhead is allocated to products based on direct labor cost. Data for year 1 show the following. ChairsDesks Sales revenue$1,046,500 $1,950,000 Direct materials 585,000 810,000 Direct labor 130,000 300,000 Required: a-1. Based on the CFO's new policy, calculate the profit margin for both chairs and desks. a-2. Which of the two products should be dropped

Answer 1

Answer and Explanation:

a. The profit margin for both chairs & decks is

But before that following calculations need to be done

Particulars           Chairs              Decks

Sales revenue  $1,046,500     $1,950,000

Less:

Direct material   $585,000      $810,000

Direct labor        $130,000       $300,000

overhead             $195,000      $450,000

                     ($645,000 × $130,000 ÷ $430,000)  

Gross profit         $136,500     $390,000

Now the profit margin is

For chairs

= $136,500 ÷ ($585,000 + $130,000 + $195,000)

= 15%

ANd, for decks

= $390,000 ÷ ($810,000 + $300,000 + $450,000)

= 25%

a-2. based on the profit margin, the chairs should be dropped