(See attached file for full problem description)
CALIFORNIA PRODUCTS CORPORATION: ANALYZE PRODUCT PROFITABILITY WITH
MACHINE CONSTRAINTS AND COMMITTED AND FLEXIBLE COSTS* (F. KOLARITSCH,
Several members of the Black family started the California Products
Corporation in 1985. From 1985 to 1990, Product I was the only product
produced, and, although profits were not high, they were sufficient to
satisfy the family stockholders.
During 1990, the management of the California Products Corporation,
mostly members of the Black family, decided to change from absorption
costing to direct costing (flexible costing) upon the advice of a
consulting firm. Product J was started into the production line in 1990
and Product K was started in 1994.
Since 1990, the company had losses or very small profits. The profit and
loss statement for 1996 (see Table I), shows that the company broke even
during that year. At the board meeting, held shortly after the financial
statements for 1996 were released, optimism was voiced concerning the
future profit prospects of the company. The reasons given for this
optimism were as follows:
product. He pointed out that all the troubles started with the
introduction of Product J and Product K. He also accused the vice
president in charge of finances of "trickery" and stated that the
contribution margin (see Table 4) was nothing except "fancy data" that
would mislead everyone.
This meeting resulted in ill feelings among the various functional staff
managers. The chairman of the board finally obtained their consent to
call in a consulting firm to investigate what had happened and to
suggest possible means of making the firm profitable.
An investigation into the flexible expenses, shown in Table 3, confirmed
that they were correct and included a charge for nor
mally expected overtime. The prices of the products had not been changed
for several years, and there was no expectation that a price change was
feasible in the next few years.
An investigation into the $821,000 committed expenses, shown in Table I
and Table 2, showed that $440,000 was joint committed
cost and that $381,000 was a separable committed cost attributable to
the company's products as follows:
I. Products J and K, it was believed, had overcome start-up troubles and
finally found acceptance by the public.
2. Products J and K are both high contribution
margin products (see Table 4).
3. During 1996 some overtime had been incurred. which it was claimed,
cut into profits. It was anticipated that overtime would not be incurred
4. The sales force had finally become convinced of the necessity of
pushing Product K because of its high contribution margin.
The profit and loss statement for the year
1997 (see Table 2) was anything but encouraging to the management of the
California Products Corporation. The company sustained a loss during
that year and, paradoxically, had a considerable backlog of unfilled
orders. The overtime was not eliminated, although the overall production
in units of output decreased by 80,000 units (see Table 5).
The board meeting that followed the release of the 1997 financial
statements was unfriendly, and everyone accused everyone else of
incompetence. Without producing any evidence, the vice president in
charge of sales accused the production people of
gross inefficiency. Evidence was, however, introduced that indicated
that sales had to be turned down because production could
not supply the goods within the normal delivery time.
The vice president in charge of production accused the salespeople of
pushing the wrong
Product I Product J
$71,000 200,000 110,000
An analysis of the joint committed costs of $440,000 showed them to be
made up of
Selling & administrative expenses' Depreciation:
Regardless of the above classification, the full amount of $821,000 was
committed costs and had been properly classified by the company.
Information gathered concerning the production process disclosed that
each product had to be worked on by each of the three machines and that
each of the three products required different machine times on the
various machines. (The average production capacity of the machines is
given in Table 6.)
It was estimated that each machine was operated about 1,800 to 2,200
hours during a normal year (practical capacity); that estimate takes
into consideration things such as maintenance, repairs, and resetting.
The maximum operational time one could expect from each of these
machines during a given year without overtaxing them and incurring
unreasonably high additional expenses was 2,200 hours.
TABLE 1 California Products Corporation Profit and Loss Statement Year
PRODUcr IPRODUcr JPRODUcr KTOTAL
costs1,503,5001,232,000300,0003,035,500 Contribution margin$ 356,500$
352,000$112,500$ 821,000 Committed expenses821,000 Net profit$0
TABLE 2 California Products Corporation Profit and Loss Statement Year
Flexible costs Contribution margin Committed expenses Net loss
TABLE 3 California Products Corporation Variable Product Costs
Indirect manufacturing expenses Selling & administrative expenses Total
*lncludes reasonable allowance for normal overtime.
Chapter 2 Short-Term Budgeting. Resource Allocations. and Capacity Cost
California Products Corporation Contribution Margins
Sales price Cost
PRODUcr IPRODUcr ]PRODUcr
K$6.0057.20$8.254.855.606.00$1.15$1.60$2.25TABLE 5 California Products
Products Sold (in Units)
TABLE 6 California Products Corporation Average Product Output Capacity
per Machine Hour* (in Units)
Machine A Machine B Machine C
330 380 540
240 215 330
.Each machine could work at any given time on one product only.
(1) Choose the optimal production plan assuming that none of the
committed costs is escapable even where there is zero production of one
or more products.
(2) What is the value of an additional 200
hours of machine C?
(3) Determine whether your proposed solu
tion in Requirement I remains optimal if
the separable committed costs for products I. J, and K are escapable if
there is no production of one or more of these products.
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