Question

Come-Clean Corporation produces a variety of cleaning compounds and solutions for both industrial and household use. While most of its products are processed independently, a few are related, such as the company’s Grit 337 and its Sparkle silver polish.

Grit 337 is a coarse cleaning powder with many industrial uses. It costs $1.60 a pound to make, and it has a selling price of $4.20 a pound. A small portion of the annual production of Grit 337 is retained in the factory for further processing. It is combined with several other ingredients to form a paste that is marketed as Sparkle silver polish. The silver polish sells for $4.00 per jar.

This further processing requires one-fourth pound of Grit 337 per jar of silver polish. The additional direct variable costs involved in the processing of a jar of silver polish are:

Other ingredients	$	0.50
Direct labor		1.32
Total direct cost	$	1.82

Overhead costs associated with processing the silver polish are:

Variable manufacturing overhead cost		25	% of direct labor cost
Fixed manufacturing overhead cost (per month):
Production supervisor	$	3,300
Depreciation of mixing equipment	$	1,500

The production supervisor has no duties other than to oversee production of the silver polish. The mixing equipment is special-purpose equipment acquired specifically to produce the silver polish. It can produce up to 1,500 jars of polish per month. Its resale value is negligible and it does not wear out through use.

Advertising costs for the silver polish total $2,700 per month. Variable selling costs associated with the silver polish are 5% of sales.

Due to a recent decline in the demand for silver polish, the company is wondering whether its continued production is advisable. The sales manager feels that it would be more profitable to sell all of the Grit 337 as a cleaning powder.

Required:

1. How much incremental revenue does the company earn per jar of polish by further processing Grit 337 rather than selling it as a cleaning powder? (Round your intermediate calculations and final answer to 2 decimal places.)

2. How much incremental contribution margin does the company earn per jar of polish by further processing Grit 337 rather than selling it as a cleaning powder? (Round your intermediate calculations and final answer to 2 decimal places.)

3. How many jars of silver polish must be sold each month to exactly offset the avoidable fixed costs incurred to produce and sell the polish? (Round your intermediate calculations to 2 decimal places.)

4. If the company sells 8,600 jars of polish, what is the financial advantage (disadvantage) of choosing to further process Grit 337 rather than selling is as a cleaning powder? (Enter any "disadvantages" as a negative value. Round your intermediate calculations to 2 decimal places.)

5. If the company sells 11,200 jars of polish, what is the financial advantage (disadvantage) of choosing to further process Grit 337 rather than selling is as a cleaning powder? (Enter any "disadvantages" as a negative value. Round your intermediate calculations to 2 decimal places.)

Answer 1

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Come-Clean Corporation
Answer 1
1/4th of Grit 337 is needed to produce 1 jar of Silver polish.
		$
Sell price per jar of silver polish		4.00
Sell revenue lost of 1/4th of Grit 337		1.05	This is $ 4.2/4
Incremental revenue per jar of silver polish		2.95
So company earn $ 2.85 as incremental revenue per jar of polish by further processing Grit 337.
Answer 2
Incremental contribution per jar:
Incremental revenue per jar		2.95	Contribution per unit of Grit 337
Further processing and selling costs
Other ingredients		0.50
Direct Labor		1.32
Variable manufacturing costs		0.33	This is 25% of Direct Labor.
Variable selling costs		0.20	This is 5% of Sell price i.e. 5 % of $ 4= $ 0.20.
Further processing and selling costs		2.35
Incremental contribution per jar		0.60
So company earn $ 0.50 as incremental contribution per jar of polish by further processing Grit 337.
Answer 3
Breakeven units
Only the cost of advertising and the cost of the production supervisor are avoidable if production of the silver polish is discontinued.
Therefore, the number of jars of silver polish that must be sold each month to justify continued processing of the Grit 337 into silver polish is:
Production supervisor		3,300.00
Advertising costs		2,700.00
Total avoidable fixed costs		6,000.00
Incremental contribution per jar		0.60
Breakeven units		10,000.00	This is calculated as Total avoidable fixed costs/ Incremental contribution per jar.
Therefore, if 12,000 jars of silver polish can be sold each month, the company would be indifferent between selling it or selling all of the Grit 337 as a cleaning powder.
If the sales of the silver polish are greater than 12,000 jars per month, then continued processing of the Grit 337 into silver polish would be advisable because the company’s total profits will be increased.
If the company can’t sell at least 12,000 jars of silver polish each month, then production of the silver polish should be discontinued.

Answer 4 and 5
Comparative income statement- different product mixes:							Workings	Silver Polish produced/sold
Units		8,600.00	11,200.00					8,600.00	11,200.00
Sales of Silver Polish @ $ 4 per jar		34,400.00	44,800.00				Conversion rate for Grit 337	0.25	0.25
Variable expenses							Grit 337 used for Silver Polish	2,150.00	2,800.00
Production cost of Grit 337 @ $ 1.60 per unit		3,440	4,480	See workings.			GR37 to be sold if not converted	2,150.00	2,800.00
Further processing & selling costs @ 2.35/jar		20,210.00	26,320.00	This is already calculated above for incremental contribution margin.
Total Variable expense		23,650.00	30,800.00
Contribution margin		10,750.00	14,000.00
Avoidable fixed costs
Production supervisor		3,300.00	3,300.00
Advertising costs		2,700.00	2,700.00
total Avoidable fixed costs		6,000.00	6,000.00
Operating Income		4,750.00	8,000.00
Units		2,150.00	2,800.00
Sales of Grit 337 @ $ 4.2 per pound		9,030.00	11,760.00	See workings.
Production cost of Grit 337 @ $ 1.60		3,440.00	4,480.00
Operating Income		5,590.00	7,280.00
Financial Impact of further process		(840.00)	720.00
		Disadvantage	Advantage
So company will have net incremental operating loss of $ 840 if it only sells 8,600 jars of silver polish.
But company will have net incremental operating profit of $ 720 if it sells 11,200 jars of silver polish.