Accounting Assignment Help With Adding and Dropping

A business aims at expanding its area of operations always. The business thus opens a number of product lines so as to increase the production and variety of products. This helps the business to expand the business and grab a major chunk of the market. Thus these product lines need to be analyzed to check whether they are performing properly or not.

Product lining refers to the group of several products which are produced by the same brand. For example, Adidas not only produces shoes but also the clothes, sports equipment etc. Therefore, Adidas has a multiple product lining where it needs to manage its products so as to maintain the profit.

Generally, the profit of one segment overcomes the loss of another segment. The loss is set off with the profit from another segment without getting notices. This leaves the segment working inefficiently. The weak product line needs to be analyzed and either it should be corrected or it must be removed from the business so as to stop it from incurring any more losses.

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Thus this study of analyzing the product lines is a part of managerial decisions. The adding or dropping decision is taken only after completely analyzing the situation and finding if it suits the business to carry on such business.

The Adding or Dropping analysis is done using the incremental analysis or the income statement method. It is seen if the product line adds to any profit to the firm and if it does, it is retained in the business or is discarded otherwise.

Reasons for forming product lines:

The product lines by the brands are basically formed with the only goal of increasing the market sales and capturing as many as consumers possible. This mainly targets the consumers already associated with the brand. The basic idea is that the consumers who are already linked with the brand and like its quality will automatically get attracted to the new products of the business and wish to buy it.

There are two main advantages of Product Lining:

1. Increased database of consumers: The diversity of products attracts more consumers. The consumers who already rely on the brand will go for the new products launched by the brand. Thus this gives the business to exploit the markets and set up the business.

2. Diversifying Markets: The product lines help the business to reach more and more people and spread their reach to different markets. It helps the business to reach the worldwide market and people coming from different walks of life. People from different socio-economic features, different backgrounds and demographic profiles can have access to the wide range of products of the business.

Analyzing the Adding or Dropping Decision:

The adding or dropping decision can be analyzed by two methods:

  1. Income Statement Method
  2. Incremental Analysis Method
Adding and Dropping

These methods can be understood using an example:

Suppose a Company operates two Product Lines A & B.
The income statement of both the products is as follows:

Particulars Product A Product B Total
Sales Revenue 400,000 800,000 1,200,000
Variable Costs (250,000) (350,000) (600,000)
Contribution Margin 150,000 450,000 600,000
Direct Fixed Costs (70,000) (100,000) (170,000)
Allocated Fixed Costs (95,000) (190,000) (285,000)
Income/ Profit (15,000) 160,000 145,000

Thus we see how Product Line A is operating under losses. These losses are compensated for by Product Line B. The profits get declined by a margin of $15,000. If the product line A is dropped the firm will be able to earn an additional profit of $15,000 and thus the profit will be $160,000.

There could be an another situation as well. If Product A’s Manufacturing is stopped, the sale of product B will fall by 10%.

Then,

Particulars Product A Product B Total
Sales Revenue 720,000 720,000
Variable Costs (315,000) (315,000)
Contribution Margin 405,000 405,000
Direct Fixed Costs (100,000) (100,000)
Allocated Fixed Costs (190,000) (190,000)
Income/ Profit 115,000 115,000

Thus we see that if the product A is discontinued, it will lead to a decline in profit from the previous situation by $30,000 (145,000-115,000).

Therefore, in such a situation it is recommended to continue the production of product A.

Let’s take another situation where there is a question of introduction of a new product in the product line.

The company plans to add another product C to the product line and removing of A.

Particulars Product A Product B Product C Total
Sales Revenue 800,000 500,000 1,300,000
Variable Costs (350,000) (250,000) (600,000)
Contribution Margin 450,000 250,000 700,000
Direct Fixed Costs (100,000) (50,000) (150,000)
Allocated Fixed Costs (190,000) (70,000) (260,000)
Income/ Profit 160,000 130,000 290,000

Thus on adding Product C to the product line there is a profit of 130,000 to the business. Thus it is highly recommended to add the product in the product line as it will help in earning goof profits to the firm.

Therefore, we can see how important it is for the business to analyze the profitability of the product lines. The higher the efficiency of the product line will be, the more it will be beneficial for the business.

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