Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 53

Decision Whether to Add or Drop

Carson Corporation produces and sells three products, Alpha, Beta, and Gamma, in a local market and in a regional market. At the end of the first quarter of the current year, the following income statement (in thousands of dollars) has been prepared:

	Total	Local	Regional
Sales revenue	$15,600	$12,000	$3,600
Cost of goods sold	12,120	9,300	2,820
Gross margin	$ 3,480	$ 2,700	$ 780
Marketing costs	1,260	720	540
Administrative costs	624	480	144
Total marketing and administrative. .	$ 1,884	$ 1,200	$ 684
Operating profits	$ 1,596	$ 1,500	$ 96

Management has expressed special concern with the regional market because of the extremely poor return on sales. This market was entered a year ago because of excess capacity. It was originally believed that the return on sales would improve with time, but after a year, no noticeable improvement can be seen from the results as reported in the preceding quarterly statement.

In attempting to decide whether to eliminate the regional market, the following information has been gathered:

	Products
	Alpha	Beta	Gamma
Sales revenue	$6,000	$4,800	$4,800
Variable manufacturing costs as a percentage of sales revenue	60%	70%	60%
Variable marketing costs as a percentage of sales revenue	3	2	2

Product Sales by Markets	Local	Regional
Alpha	$4,800	$1,200
Beta	3,600	1,200
Gamma	3,600	1,200

All administrative costs and fixed manufacturing costs would not be affected by eliminating the regional market. Marketing costs that are not listed above as variable are fixed for the period and separable by market. Fixed marketing costs assigned to the regional market would be saved if that market was eliminated.

Required

a.Assuming there are no alternative uses for Carson’s present capacity, would you recommend dropping the regional market? Why or why not?

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b.Prepare the quarterly income statement showing contribution margins by products. Do not allocate fixed costs to products.

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c. It is believed that a new product can be ready for sale next year if Carson decides to go ahead with continued research. The new product would replace Gamma and can be produced by simply converting equipment presently used in producing product Gamma. This conversion will increase fixed costs by $120,000 per quarter. What must be the minimum contribution margin per quarter for the new product to make the changeover financially feasible?

Step 1 of 9

Pricing decisions:

A pricing decision is a mix of key aspects such as cost of production, marketing strategy, organization structure and the firm’s image. The following are the detailed understanding of the aspects:

• Cost of production: It is depends on the efficiency of the manufacturing process/productivity. Higher productivity can help the company to lower prices.

• Marketing strategy: It is depending on the strategy followed by the company to market its product; marketing expenses are built into the price. Hence by following a low cost strategy pricing can be lowered or by following a high cost strategy price has to be increased.

• Organization structure: It is depends on how the organization is structured and how the costs are allocated at various levels.

• Firm's image: It plays a crucial role in pricing. a reputed firm can command a higher pricing as compared to an unheard of firm.