Economics

Product 1Product 2

1988199019881990

Expected selling price$62 $62 $54 $54 

Standard material cost$16 $16 $27 $27 

Standard labor cost$6 $6 $3 $3 

Overhead rate434.45%563%434.45%563%

Overhead allocation

(labor cost X overhead rate)$26.07 $33.78$13.03 $16.89 Gross margin$13.93$6.22 $10.97$7.11 

Gross margin as % of selling price

(Gross margin/ selling price)22.47%10% 20.31%13.16%

As we can see from the above calculations the Gross Margin as a % of the selling price inexorably going down from 1988 to 1990 for both products 1 and 2. There are significant unavoidable costs, which are increasing the overhead allocation rate and dragging Gross Margin down. Both products are becoming less profitable and hence new candidates for outsourcing. We are witnessing a death spiral.

Also from Exhibit 2:

Overhead by Account Number

1000$7,806 $5,572 $5,679 

15006,8245,8835,928

20003,7942,0312,115

30002,5291,3541,410

40008,8887,3607,433

500024,46020,06320,274

80005,9463,7443,744

90006,7715,9485,987

110005,0113,1503,030

1200028,07715,02715,683

140009,7848,0258,110

Total Overhead$109,890 $78,157 $79,393 

% change in Overhead from 1988 to 1990-27.75%

Overhead allocation rate as a % of direct labor dollars (Total Overhead/ Total DL)434.45%577.36%563%

% Change in Overhead from 1988 to 1990 = (($79,393 - $109,890)/($109,890)) X 100 = -27.75%

Overhead Allocation Rate as a % of Direct Labor Dollars for each of the three years:

•1988: ($109,890/$25294) X 100 = 434.45%

•1989: ($78,157/$13,537) X 100 = 577.36%

•1990: ($79,393/$14,102) X 100 = 563%

c)From the table in the problem:

Product 1Product 2

1988199019881990

Expected selling price$62 $62 $54 $54 

Standard material cost$16 $16 $27 $27 

Standard labor cost$6 $6 $3 $3 

Overhead rate434.45%563%434.45%563%

Overhead allocation

(labor cost X overhead rate)$26.07 $33.78$13.03 $16.89 Gross margin$13.93$6.22 $10.97$7.11 

Gross margin as % of selling price

(Gross margin/ selling...