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Chapter 16: Problem 38

The Seattle Recycling Company (SRC) purchases old water and soda bottles and recycles them to produce plastic covers for outdoor furniture. The company processes the bottles in a special piece of equipment that first melts, then reforms the plastic into large sheets that are cut to size. The edges from the cut pieces are sold for use as package filler. The filler is considered a byproduct. SRC can produce 25 table covers, 75 chair covers, and 5 pounds of package filler from 100 pounds of bottles. In June, SRC had no beginning inventory. It purchased and processed 120,000 pounds of bottles at a cost of \(\$ 600,000 .\) SRC sold 25,000 table covers for \(\$ 12\) each, 80,000 chair covers for \(\$ 8\) each, and 5,000 pounds of package filler at \(\$ 1\) per pound. 1\. Assume that SRC allocates the joint costs to table and chair covers using the sales value at splitoff method and accounts for the byproduct using the production method. What is the ending inventory cost for each product and gross margin for SRC? 2\. Assume that SRC allocates the joint costs to table and chair covers using the sales value at splitoff method and accounts for the byproduct using the sales method. What is the ending inventory cost for each product and gross margin for SRC? 3\. Discuss the difference between the two methods of accounting for byproducts, focusing on what conditions are necessary to use each method.

Short Answer

Expert verified
In summary, when using the sales value at splitoff method for joint cost allocation and production method for byproduct accounting, the ending inventory costs for table covers is \$7.66, for chair covers is \$5.11, and the gross margin is \$241,520. When using the sales value at splitoff method for joint cost allocation and sales method for byproduct accounting, the ending inventory costs for table covers is \$7.66, for chair covers is \$5.11, and the gross margin is \$246,520. The production method is appropriate when byproducts have insignificant value, while the sales method is useful when byproducts have significant value compared to main products.

Step by step solution

01

Part 1: Sales Value at Splitoff Method for Joint Costs and Production Method for Byproduct Accounting

In this case, we will allocate the joint costs to table and chair covers using the sales value at splitoff method and account for the byproduct using the production method. Step 1: Find the sales value at splitoff - Table covers: \(25,000 \times \$12 = \$300,000\) - Chair covers: \(80,000 \times \$8 = \$640,000\) Step 2: Calculate the joint cost allocation ratio - Total Sales Value at Splitoff: \(\$300,000 + \$640,000 = \$940,000\) - Ratio for Table Covers: \(\frac{\$300,000}{\$940,000} = 0.3191\) - Ratio for Chair Covers: \(\frac{\$640,000}{\$940,000} = 0.6808\) Step 3: Allocate joint costs - Joint costs for Table Covers: \(600,000 \times 0.3191 = \$191,460\) - Joint costs for Chair Covers: \(600,000 \times 0.6808 = \$408,480\) Step 4: Account for byproduct (Package filler) using the production method - Revenue from Package filler: \(5,000 \times \$1 = \$5,000\) - Allocate package filler revenue: \(600,000 - 5,000 = \$595,000\) Step 5: Calculate ending inventory cost - Table Covers: \(\frac{\$191,460}{25,000} = \$7.66\) - Chair Covers: \(\frac{\$408,480}{80,000} = \$5.11\) Step 6: Calculate gross margin - Revenue: \(\$300,000 + \$640,000 + \$5,000 = \$945,000\) - Cost of Goods Sold (COGS): \(\$7.66 \times 25,000 + \$5.11 \times 80,000 = \$703,480\) - Gross Margin: \(\$945,000 - \$703,480 = \$241,520\) In this scenario, the ending inventory cost for table covers is \$7.66, chair covers is \$5.11, and the gross margin is \$241,520.
02

Part 2: Sales Value at Splitoff Method for Joint Costs Allocation and Sales Method for Byproduct Accounting

Here, we will allocate the joint costs to table and chair covers using the sales value at splitoff method and account for the byproduct using the sales method. Step 1 to 4 are the same as in Part 1. Step 5: Calculate ending inventory cost - Table Covers: \(\frac{\$191,460}{25,000} = \$7.66\) - Chair Covers: \(\frac{\$408,480}{80,000} = \$5.11\) Step 6: Calculate gross margin using the sales method for byproduct accounting - Revenue: \(\$300,000 + \$640,000 + \$5,000 = \$945,000\) - Cost of Goods Sold (COGS): \(\$7.66 \times 25,000 + \$5.11 \times 80,000 = \$703,480\) - Other Income (Byproduct Revenue): \(\$5,000\) - Gross Margin: \((\$945,000 - \$703,480) + \$5,000 = \$246,520\) Under this scenario, the ending inventory cost for table covers is \$7.66, chair covers is \$5.11, and the gross margin is \$246,520.
03

Part 3: Comparing the Production and Sales Method for Byproduct Accounting

The production method for byproduct accounting reduces the joint costs by the revenue generated from the byproduct. This method is used when the byproduct has a relatively insignificant value compared to the main products. On the other hand, the sales method treats the revenue from the byproduct as other income and does not reduce the joint costs. This method is used when the byproduct has a more significant value compared to the main products. In the given exercise, the gross margin is higher when using the sales method (\$246,520) compared to the production method (\$241,520). This signifies that in this case, the sales method might be more appropriate if the byproduct has a significant value compared to the main products.

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Key Concepts

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

Joint Cost Allocation
Understanding joint cost allocation is vital in manufacturing because it helps determine how costs are shared among different products that are produced together. In settings like SRC, multiple products emerge from a single production process from which joints costs arise. To distribute these costs accurately, manufacturers apply joint cost allocation methods. A common approach seen here is allocating costs based on the sales value at the point where the products can first be separately identified, known as the splitoff point. This requires understanding the market value of each product to assign costs proportionately based on their potential revenue. Doing so allows SRC to allocate joint costs in a manner reflecting each product's contribution to overall sales, offering a fair and logical distribution of costs.
Byproduct Accounting Methods
Byproducts are secondary outputs from the manufacturing process, often of less value but still revenue-generating. SRC uses materials like package filler as a byproduct offering valuable insights into accounting practices. There are two primary methods in byproduct accounting:
  • The **Production Method**: This treats byproduct revenue as a reduction of the initial joint processing costs. Essentially, the income from byproducts decreases the total expenses incurred, leaving an adjusted cost for the main products.
  • The **Sales Method**: Contrary to the production method, this method treats byproduct revenue as an income stream separate from the main production. Thus, the overall profit would reflect this added income, rather than reducing costs.
Using appropriate methods depends largely on the byproduct's significance relative to the main products. If a byproduct holds notable financial value, the sales method usually offers more accurate financial insights.
Sales Value at Splitoff Method
The sales value at splitoff method is key in any joint cost allocation process because it allocates joint costs based on the relative sales value of products immediately after they split from the overall production process. This method is advantageous because it uses objective market data to allocate costs, minimizing potential bias. To utilize this properly, a business must determine the total sales value for each product at splitoff. This allows them to calculate the proportionate share of joint costs each product should cover. For example, SRC calculated sales values for table covers and chair covers independently. By understanding these numbers, they allocate costs in a way that mirrors each product's ability to generate revenue, ensuring fairness and transparency in costing structures.
Gross Margin Calculation
Gross margin is a critical measure of a company's financial health and performance. To compute the gross margin, SRC needs to subtract the total cost of goods sold (COGS) from the total revenue. For accurate calculation, it factors in all the products' costs, including both direct and joint costs allocated. By accounting for the revenue generated by products like table and chair covers along with any adjustments for byproducts, the gross margin reveals how effectively SRC manages its production and sales costs. A higher gross margin indicates a stronger control over production-related expenses and pricing strategies, leading to greater profitability. In SRC's scenario, comparing two byproduct accounting methods highlights the potential for varying gross margins based on financial strategy choices.
Production and Sales Methods
In cost accounting, the production and sales methods refer to the different approaches for managing and recording the financial impact of byproducts. SRC's example illustrates how each method affects the financial outcome differently. The **Production Method** deducts byproduct sales from the cost basis, aiming for simplicity and directly lowering overall costs. This can smooth out cost reporting, ideal for products with minimal byproduct influence. The **Sales Method** credits byproduct sales as other income, ensuring these secondary products get a distinct financial acknowledgment, allowing for detailed profitability tracking. The choice between these methods is strategic, often resting on how the company's financial goals align with the relative value of its byproducts. When byproducts possess enough value to impact profits, the sales method often provides more nuanced insights.

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Most popular questions from this chapter

(CMA, adapted) Newcastle Mining Company (NMC) mines coal, puts it through a one-step crushing process, and loads the bulk raw coal onto river barges for shipment to customers. NMC's management is currently evaluating the possibility of further processing the raw coal by sizing and cleaning it and selling it to an expanded set of customers at higher prices. The option of building a new sizing and cleaning plant is ruled out as being financially infeasible. Instead, Amy Kimbell, a mining engineer, is asked to explore outside-contracting arrangements for the cleaning and sizing process. Kimbell puts together the following summary: Kimbell also learns that \(75 \%\) of the material loss that occurs in the cleaning and sizing process can be salvaged as coal fines, which can be sold to steel manufacturers for their furnaces. The sale of coal fines is erratic and NMC may need to stockpile them in a protected area for up to one year. The selling price of coal fines ranges from \(\$ 14\) to \(\$ 25\) per ton and costs of preparing coal fines for sale range from \(\$ 3\) to \(\$ 5\) per ton. 1\. Prepare an analysis to show whether it is more profitable for NMC to continue selling raw bulk coal or to process it further through sizing and cleaning. (Ignore coal fines in your analysis.) 2\. How would your analysis be affected if the cost of producing raw coal could be held down to \(\$ 20\) per ton? 3\. Now consider the potential value of the coal fines and prepare an addendum that shows how their value affects the results of your analysis prepared in requirement 1.

Joint-cost allocation, insurance settlement. Quality Chicken grows and processes chickens. Each chicken is disassembled into five main parts. Information pertaining to production in July 2017 is as follows: $$\begin{array}{lcc} & & \text { Wholesale Selling Price per Pound When } \\\\\text { Parts } & \text { Pounds of Product } & \text { Production Is Complete } \\\\\hline \text { Breasts } & 100 & \$ 0.55 \\\\\text { Wings } & 20 & 0.20 \\\\\text { Thighs } & 40 & 0.35 \\\\\text { Bones } & 80 & 0.10 \\\\\text { Feathers } & 10 & 0.05\end{array}$$ Joint cost of production in July 2017 was \(\$ 50\) A special shipment of 40 pounds of breasts and 15 pounds of wings has been destroyed in a fire. Quality Chicken's insurance policy provides reimbursement for the cost of the items destroyed. The insurance company permits Quality Chicken to use a joint-cost- allocation method. The splitoff point is assumed to be at the end of the production process. 1\. Compute the cost of the special shipment destroyed using the following: a. Sales value at splitoff method b. Physical-measure method (pounds of finished product) 2\. What joint-cost-allocation method would you recommend Quality Chicken use? Explain.

Provide three reasons for allocating joint costs to individual products or services.

What is a joint cost? What is a separable cost?

Distinguish between the sales value at splitoff method and the NRV method.
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