EXERCISE 8-21 (CONTINUED)

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.