Deck 8: Cost Allocation: Practices

Question 1

Joint Cost versus Common Costs
What is the difference between joint costs and common costs?

Answer 1

Solution to Joint Costs versus Common Costs (15 minutes)
When the direct input used in a production process results in two or more predetermined end products,the cost of the input is a joint cost.The cost of crude oil,for the production of petrol,diesel,and chemicals,is a joint cost.The cost would be divided among the various products produced.When distilling the crude,the quantities of the end products are produced in fixed proportions.That is,the fraction of petrol per barrel of crude is a constant because of the technical constraints of refining.
Common costs are the costs of a facility or resource shared by several users.The costs incurred to run the plant or the process,where two separate products are produced,are common costs (e.g. ,insurance and depreciation on plant,the cost of the machine operator,or the costs of the maintenance department).In this case we do not necessarily know an exact composition of the outputs that come out of the facility or process.Several different products or different combinations of outputs may be produced in varying proportions.
Technically speaking,joint costs result when joint products are produced in fixed proportions from a single input (e.g. ,crude oil).Common costs are broader and include joint costs but do not necessarily require the outputs to be in fixed proportions. Therefore,incur additional processing costs of $45,000 and process B further.Notice the joint cost of $400,000 being sunk does not enter the analysis.

Question 2

Beware of Unit Costs,Costs Beyond the Split-off Point are not Necessarily all Variable
Table 8-12 in the text allocates joint costs using net realizable value as the allocation base.What critical assumptions underlie the analysis in Table 8-12? That is,under what circumstances can the data in this table be used to assess product line profitability?

Answer 2

Solution to Beware of Unit Costs,Costs Beyond the Split-off Point are not Necessarily all Variable (20 minutes)
"Beware of unit costs." Table 8-12 relies on the line item "Costs beyond the split-off point." These numbers are stated as unit costs.For example,80¢ is the cost of processing the chicken fillets beyond the split-off point to the selling point.How was this 80¢ determined? Are these unit costs variable costs or do they contain any fixed or common costs?
For example,suppose the 80¢ contains the fixed cost of a machine used to process the fillets.Then,one is introducing a cost allocation into a product line profitability assessment.For example,if volumes increased,the allocated unit cost of the machine would fall and the 80¢ falls.The firm's cash flow does not fall by 80¢ every time it processes another breast if the 80¢ contains a unitized fixed cost.Also,if the 80¢ contains a common cost,then again the analysis in Table 8-12 is misleading.For example,suppose a maintenance worker maintains all the equipment used to further process fillets,wings,and drumsticks.This maintenance person's cost is a common cost.If the maintenance person's salary is allocated to the three products' "costs beyond the split-off point," then these unit costs do not represent the marginal cost of processing an additional part.
Therefore,one critical assumption underlying Table 8-12 is that the unit costs stated as the costs beyond the split-off point do not contain any fixed or common cost.

Question 3

Allocating joint costs
Sonimad Sawmill manufactures two lumber products from a joint milling process.The two products developed are mine support braces (MSBs)and unseasoned commercial building lumber (CBL).A standard production run incurs joint costs of $300,000 and results in 60,000 units of MSB and 90,000 units of CBL.Each unprocessed unit of MSB sells for $2 per unit and each unprocessed unit of CBL sells for $4 per unit.
If the CBL is processed further at a cost of $200,000,it can be sold at $10 per unit but 10,000 units are unavoidably lost (with no discernible value).The MSB units can be coated with a preservative at a cost of $100,000 per production run and then sold for $3.50 each.
Required:
a.If no further work is done after the initial milling process,calculate the cost of CBL using physical quantities to allocate the joint cost.
b.If no further work is done after the initial milling process,calculate the cost of MSB using relative sales value to allocate the joint cost.
c.Should MSB and CBL be processed further or sold immediately after initial milling?
d.Given your decision in (c),prepare a schedule computing the completed cost assigned to each unit of MSB and CBL as charged to finished goods inventory.Use net realizable value for allocating joint costs.

Answer 3

Solution to Allocating Joint Costs (CMA adapted)(30 minutes)
a.Allocation using physical quantities
b.Allocation using relative sales value
c.Processing further
d.Allocation using net realizable value

Question 4

Processing Further
Walters Company produces 15,000 pounds of Product A and 30,000 pounds of Product B each week by incurring a joint cost of $400,000.These two products can be sold as is or processed further.Further processing of either product does not delay the production of subsequent batches of the joint product.Data regarding these two products are as follows: To maximize Walters Company's manufacturing contribution margin,how much total separate variable costs of further processing should be incurred each week?

Question 5

Death Spiral
An insurance company has the following profitability analysis of its services: The fixed costs are distributed equally among the services and are not avoidable if one of the services is dropped.
What is the profitability of the remaining services if all services with losses are dropped?

Question 6

Evaluating Decision Alternatives Involving Common Costs
Cosmo Inc.operates two retail novelty stores:the Mall Store and the Town Store.Condensed monthly operating income data for Cosmo Inc.for November are presented in the accompanying table.Additional information regarding Cosmo's operations follows the statement.
• One-fourth of each store's direct fixed expenses would continue through December of next year if either store were closed.
• Cosmo allocates common fixed expenses to each store on the basis of sales dollars.
• Management estimates that closing the Town Store would result in a 10 percent decrease in Mall Store sales,while closing the Mall Store would not affect Town Store sales.
• The operating results for November are representative of all months.
Required:
a.A decision by Cosmo Inc.to close the Town Store would result in a monthly increase (decrease)in Cosmo's operating income during next year of how much?
b.Cosmo is considering a promotional campaign at the Town Store that would not affect the Mall Store.Increasing monthly promotional expenses at the Town Store by $5,000 in order to increase Town Store sales by 10 percent would result in a monthly increase (decrease)in Cosmo's operating income during next year of how much?
c.Half of Town Store's dollar sales are from items sold at variable cost to attract customers to the store.Cosmo is considering deleting these items,a move that would reduce the Town Store's direct fixed expenses by 15 percent and result in the loss of 20 percent of Town Store's remaining sales volume.This change would not affect the Mall Store.A decision to eliminate the items sold at cost would result in a monthly increase (decrease)in Cosmo's operating income during next year of how much?