91Ó°ÊÓ

Earl's Hurricane Lamp Oil Company produces both A-1 Fancy and B Grade Oil. There are approximately \(\$ 9,000\) in joint costs that Earl may allocate using the relative sales value at splitoff or the net realizable value approach. Before splitoff, A-1 sells for \(\$ 20,000\) while \(B\) grade sells for \(\$ 40,000\). After an additional investment of \(\$ 10,000\) after splitoff, \(\$ 3,000\) for \(B\) grade and \(\$ 7,000\) for \(A-1,\) both the products sell for \(\$ 50,000\) What is the difference in allocated costs for the \(A-1\) product assuming applications of the net realizable value and the net realizable value at splitoff approach? 1\. A-1 Fancy has \(\$ 1,300\) more joint costs allocated to it under the net realizable value approach than the sales value at splitoff approach. 2\. A-1 Fancy has \(\$ 1,300\) less joint costs allocated to it under the net realizable value approach than the sales value at splitoff approach. 3\. A-1 Fancy has \(\$ 1,500\) more joint costs allocated to it under the net realizable value approach than the sales value at splitoff approach. 4\. A-1 Fancy has \(\$ 1,500\) less joint costs allocated to it under the net realizable value approach than the sales value at splitoff approach.

Step by step solution

01

Calculate cost allocations under the sales value at splitoff approach

To calculate the cost allocation under the sales value at splitoff approach, we need to follow these steps: 1. Calculate the combined sales value of both A-1 Fancy and B Grade before splitoff. 2. Calculate the cost allocation ratios for A-1 Fancy and B Grade. 3. Allocate the joint costs based on the ratios calculated. Let's perform these calculations 1. Combined sales value before splitoff: \(Combined\,Sales\,Value = Sales\,Value_{A-1\,Fancy} + Sales\,Value_{B\,Grade} = \$ 20,000 + \$ 40,000 = \$ 60,000\) 2. Calculate cost allocation ratios: Ratio for A-1 Fancy: \(\frac{\$20,000}{\$60,000} = \frac{1}{3}\) Ratio for B Grade: \(\frac{\$40,000}{\$60,000} = \frac{2}{3}\) 3. Allocate the joint costs based on the ratios calculated: \(Joint\,Cost_{A-1\,Fancy} = Joint\,Cost * Ratio_{A-1\_Fancy} = \$ 9,000 * \frac{1}{3} = \$ 3,000\) \(Joint\,Cost_{B\,Grade} = Joint\,Cost * Ratio_{B\_Grade} = \$ 9,000 * \frac{2}{3} = \$ 6,000\)

02

Calculate cost allocations under the net realizable value approach

To calculate cost allocation under the net realizable value approach, we need to follow these steps: 1. Calculate the net realizable value of both A-1 Fancy and B Grade. 2. Calculate the cost allocation ratios for A-1 Fancy and B Grade. 3. Allocate the joint costs based on the ratios calculated. 1. Calculate net realizable value: Net realizable value for A-1 Fancy: \(\$50,000 - \$ 7,000 = \$ 43,000\), Net realizable value for B Grade: \(\$50,000 - \$ 3,000 = \$ 47,000\) 2. Calculate cost allocation ratios: Ratio for A-1 Fancy: \(\frac{\$43,000}{\$90,000} = \frac{43}{90}\) Ratio for B Grade: \(\frac{\$47,000}{\$90,000} = \frac{47}{90}\) 3. Allocate the joint costs based on the ratios calculated: \(Joint\,Cost_{A-1\,Fancy} = Joint\,Cost * Ratio_{A-1\_Fancy} = \$ 9,000 * \frac{43}{90} = \$ 4300\) \(Joint\,Cost_{B\,Grade} = Joint\,Cost * Ratio_{B\_Grade} = \$ 9,000 * \frac{47}{90} = \$ 4700\)

03

Determine the difference in allocated costs for A-1 Fancy

We will now find the difference in allocated costs for A-1 Fancy using the sales value at splitoff approach and the net realizable value approach. Difference: \(\$ 4,300 - \$ 3,000= \$ 1,300\) This means A-1 Fancy has $1,300 more joint costs allocated to it under the net realizable value approach than the sales value at splitoff approach. Hence, the correct answer is option 1.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Net Realizable Value Approach

The net realizable value (NRV) approach is a cost allocation method that focuses on the final value of products after additional processing. It considers the potential revenue from each product minus any additional costs incurred after the splitoff point. By evaluating the estimated selling price and subtracting further processing costs, it provides a clearer picture of each product's profitability.

To allocate joint costs using the NRV approach:

• First, determine the net realizable value for each product. This involves subtracting the additional costs from the final sales price. For instance, A-1 Fancy's net realizable value is calculated as \(50,000 (final sales price) minus \)7,000 (additional costs), resulting in \(43,000.
• Next, calculate the proportion of NRV each product contributes to the total NRV. For A-1 Fancy and B Grade, the total NRV combined is \)90,000, with A-1 contributing \(43,000 and B Grade \)47,000.
• Allocate the \(9,000 joint costs based on these proportions. A-1's share is \)4,300, calculated as \((43,000/90,000) \times 9,000\).

This method is particularly useful if the focus is on maximizing profitability post-processing.

Sales Value at Splitoff Approach

The sales value at splitoff approach is another method used to allocate joint costs. This approach relies on the immediate sales value of products at the point of separation, without considering further processing.

Using this method involves:

• Calculating the total sales value at the splitoff point by summing up the sales values of all products before further processing. For example, A-1 Fancy has a sales value of \(20,000, while B Grade has \)40,000, making the combined sales value \(60,000.
• Determining each product's proportion of the total sales value. A-1 Fancy contributes \)20,000, which is one-third of the total, and B Grade contributes two-thirds.
• Allocating the joint costs based on these proportions. For A-1, this is \((1/3) \times 9,000\), which equals $3,000.

This approach is straightforward and reflects the products' initial market values, making it useful when further processing is not a focus.

Joint Costs

Joint costs arise in production processes where multiple products are derived from a single initial input. These costs are incurred before the splitoff point, where the products become individually identifiable.

Understanding joint costs is crucial because:

• It helps in understanding shared production costs that impact multiple products. These costs can include direct materials, labor, and overhead that cannot be individually assigned to specific products.
• Allocating these costs accurately is essential for evaluating product profitability and making informed business decisions.
• The methods of allocation, such as the NRV approach and the sales value at splitoff approach, offer different perspectives and can significantly influence how costs are distributed across products.

Proper allocation of joint costs ensures that companies are accurately tracking product performance and making strategic pricing, production, and marketing decisions.