91Ó°ÊÓ

Garden Labs produces a drug used for the treatment of arthritis. The drug is produced in batches. Chemicals costing \(\$ 50,000\) are mixed and heated, then a unique separation process extracts the drug from the mixture. A batch yields a total of 3,000 gallons of the chemicals. The first 2,500 gallons are sold for human use while the last 500 gallons, which contain impurities, are sold to veterinarians. The costs of mixing, heating, and extracting the drug amount to \(\$ 155,000\) per batch. The output sold for human use is pasteurized at a total cost of \(\$ 130,000\) and is sold for \(\$ 600\) per gallon. The product sold to veterinarians is irradiated at a cost of \(\$ 20\) per gallon and is sold for \(\$ 450\) per gallon. In March, Garden, which had no opening inventory, processed one batch of chemicals. It sold 2,000 gallons of product for human use and 300 gallons of the veterinarian product. Garden uses the net realizable value method for allocating joint production costs. 1\. How much in joint costs does Garden allocate to each product? 2\. Compute the cost of ending inventory for each of Garden's products. 3\. If Garden were to use the constant gross-margin percentage NRV method instead, how would it allocate its joint costs? 4\. Calculate the gross margin on the sale of the product for human use in March under the constant gross-margin percentage NRV method. 5\. Suppose that the separation process also yields 300 pints of a toxic byproduct. Garden currently pays a hauling company \(\$ 6,000\) to dispose of this byproduct. Garden is contacted by a firm interested in purchasing a modified form of this byproduct for a total price of \(\$ 7,000\). Garden estimates that it will cost about \(\$ 35\) per pint to do the required modification. Should Garden accept the offer?

Step by step solution

01

Calculate NRV for Human Use Product

For the human use product, we have \(2,500\) gallons sold at \(\$600\) per gallon. The NRV is: \(2,500 \text{ gallons} \times \$600 \text{/gallon} = \$1,500,000\)

02

Calculate NRV for Veterinary Product

For the veterinary product, we have \(500\) gallons sold at \(\$450\) per gallon. The NRV is: \(500 \text{ gallons} \times \$450 \text{/gallon} = \$225,000\) Step 2: Allocate joint costs using the NRV method

03

Calculate Joint Cost Allocation Ratio

To allocate the joint costs, we first need to find the total NRV, which is the sum of the NRVs for both products: \(\$1,500,000 + \$225,000 = \$1,725,000\) Next, calculate the joint cost allocation ratio for each product by dividing each product's NRV by the total NRV: - Human use product: \(\$1,500,000 \div \$1,725,000 = 0.8696\) - Veterinary product: \(\$225,000 \div \$1,725,000 = 0.1304\)

04

Allocate Joint Costs

Joint costs are given as \(\$155,000\). Now, we can allocate these costs to each product using the calculated ratios: - Human use product: \(\$155,000 \times 0.8696 = \$134,788\) (rounded) - Veterinary product: \(\$155,000 \times 0.1304 = \$20,212\) (rounded) Step 3: Compute the cost of ending inventory for each product

05

Compute Ending Inventory for Human Use Product

March sales were \(2,000\) gallons, so \(500\) gallons remain. The cost per gallon is: \(\frac{\134,788}{2,500 \text{ gallons}} = \$53.9152 \text{/gallon}\). The ending inventory value for the human use product is: \(500 \text{ gallons} \times \$53.9152 \text{/gallon} = \$26,958\)

06

Compute Ending Inventory for the Veterinary Product

March sales were \(300\) gallons, so \(200\) gallons remain. The cost per gallon is: \(\frac{\$20,212}{500 \text{ gallons}} = \$40.424 \text{/gallon}\). The ending inventory value for the veterinary product is: \(200 \text{ gallons} \times \$40.424 \text{/gallon} = \$8,085\) Step 4: Calculate the gross margin on the sale of the product for human use in March under the constant gross-margin percentage NRV method.

07

Calculate Gross Margin

Sales for the human use product in March were \(2,000\) gallons at \(\$600\) per gallon. The cost of goods sold is \(2,000\) gallons at \(\$53.9152\) per gallon. Gross margin = Sales - Cost of Goods Sold = \((2,000 \times \$600) - (2,000 \times \$53.9152) = \$1,200,000 - \$107,830.4 = \$1,092,169.6 \) Step 5: Determine whether Garden Labs should accept the offer to modify and sell the toxic byproduct.

08

Calculate the Profit

It is estimated to cost \(\$35\) per pint to modify the byproduct, so the total cost of modification is \(300 \times \$35 = \$10,500\). The sale price for the modified byproduct is \(\$7,000\). Profit = Sale Price - Cost of Modification - Disposal Cost = \(\$7,000 - \$10,500 - \$6,000 = -\$9,500\) Since the profit is negative, Garden Labs should not accept the offer to modify and sell the toxic byproduct.

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Key Concepts

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

Net Realizable Value Method

The Net Realizable Value (NRV) method is an important concept in accounting, particularly when it comes to joint cost allocation for manufacturing companies producing multiple products from a single process. It simplifies the process of assigning costs to different products based on their final market values.

To calculate the NRV, you need to consider the final selling price of a product minus any additional costs that will be incurred before the sale. For instance, if a company like Garden Labs sells a product for $600 per gallon and incurs additional post-production costs, these should be subtracted to find the product’s NRV.

In the provided exercise, we look at the allocation of joint production costs between two products: a drug for human use and a similar product for veterinary use. The NRV for each product is calculated by multiplying the gallons produced by the price per gallon. These values are then used to determine the proportion of total joint costs allocated to each product based on the NRV ratio, which represents the product’s share of the total joint cost value.

Cost of Ending Inventory

Understanding the cost of ending inventory is crucial for proper inventory management and financial reporting. The cost of ending inventory represents the value of the unsold stock at the end of a financial period and appears on a company's balance sheet as an asset.

Calculating the cost of ending inventory involves taking the allocated joint costs per unit and multiplying by the quantity of unsold products. This process ensures an accurate reflection of the product costs that are carried over into the next period. In the case of Garden Labs, this means calculating the cost per gallon for both the human and veterinary products based on the joint costs allocated to each, and multiplying by the unsold gallons at month-end.

Accurately determining the cost of ending inventory is a key step in financial accounting as it impacts both the cost of goods sold and net income figures. For students, mastering this calculation enhances their understanding of how production costs flow through to financial statements.

Constant Gross-Margin Percentage NRV Method

The Constant Gross-Margin Percentage Net Realizable Value (NRV) method is an extension of the NRV concept, used to maintain a constant gross margin rate across all products. It differs from the basic NRV method by first calculating a total NRV for all products, then allocating joint costs in a way that ensures the same percentage of gross margin on every product.

To implement this method, first, the overall gross margin for all products is determined by subtracting total joint costs from the total NRV. The gross margin percentage is then calculated and applied uniformly to each product to divide joint costs proportionally.

In our exercise, using the constant gross-margin percentage NRV method would result in a different allocation of joint costs, potentially affecting the profitability of each product line. Understanding this method provides students with insight into alternative cost allocation strategies, particularly relevant in an environment with diverse product ranges or when aiming for pricing consistency.