3. The president was probably correct in being concerned about the profit-
ability of the products, but the problem is apparently with the specialty
product line rather than the standard product line. Traditional overhead
cost assignment using a volume-based measure has resulted in the
high-volume product subsidizing the low-volume product. Thus, unit
costs for both products are badly distorted. These distorted costs have
had a major impact on management’s pricing policies and on manage-
ment’s perception of the margin being realized on each product. The
specialty briefcases are apparently being sold at a loss even without
considering nonmanufacturing costs:
Standard
Briefcases Specialty
Briefcases
Selling price per unit... $36.00 $40.00
Unit product cost ... 29.98 45.09
Gross margin (loss) per unit.. $ 6.02 ($ 5.09)
Based on these data, the company should not shift its resources entirely
to the production of specialty briefcases. Whether or not the specialty
briefcases can be made profitable depends on a number of factors in-
cluding the sensitivity of the market to an increase in the selling price of
the specialty line.
Case 8-34 (continued)
Note to the Instructor: You may want to mention to your class that be-
fore any decision can be made regarding dropping a product, a careful
analysis will have to be made of the potential avoidable costs. Some of
the costs included in the unit product costs are probably costs of idle
capacity and organization-sustaining costs that are not relevant.
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