Question

Integrative Case 11-77 (Algo) Effect of Cost Allocation on Pricing and Make versus Buy Decisions (LO 11- 7,8) Ag-Coop is a large farm cooperative with a number of agriculture-related manufacturing and service divisions. As a cooperative, it pays no federal income taxes. The company owns a fertilizer plant that processes and mixes petrochemical compounds into three brands of agricultural fertilizer: greenup, maintane, and winterizer. The three brands differ with respect to selling price and the proportional content of basic chemicals. Ag-Coop's Fertilizer Manufacturing Division transfers the completed product to the cooperative's Retail Sales Division at a price based on the cost of each type of fertilizer plus a markup. The Manufacturing Division is completely automated so that the only costs it incurs are the costs of the petrochemical feedstocks plus overhead that is considered fixed. The primary feedstock costs $180 per pound. Each 100 pounds of feedstock can produce either of the following mixtures of fertilizer. Greenup Maintane Winterior Output Schedules (in pounds) А B 60 50 20 10 20 40 Production is limited to the 850,000 kilowatt-hours monthly capacity of the dehydrator. Due to different chemical makeup, each brand of fertilizer requires different dehydrator use. Dehydrator usage in kilowatt-hours per pound of product follows. Product Greenup Maintane Winterizer Kilowatt-hour Usage per Pound 34 26 42 Monthly fixed costs are $85,000. The company currently is producing according to output schedule A. Joint production costs including fixed overhead are allocated to each product on the basis of weight.

Answer 1

a.   Output:

	Output Mix	Kwh per lb.		Kwh per100 lbs. Input
Greenup.........................................................	60	%	34			2,040
Maintane.......................................................	20		26			520
Winterizer......................................................	20		42			840
						3,400

Maximum processing:	=	850,000 kwh ÷ 3,400 kwh per 100 lbs.
	=	25,000 lbs. of input

Fixed cost allocation....................................................	$85,000	÷	25,000	=	$3.40	per lb.
Feedstock cost.............................................................					1.80
Joint costs...........................................................					$5.20	per lb.

Allocated cost per lb. = $5.20 for Greenup, Maintane, and Winterizer.

b.   Total joint cost incurred in processing 25,000 lbs. of input =

      $85,000 + (25,000 x $1.80) = $130,000

      Quantities of each product produced:

Greenup.........................................................	25,000	x	.6	=	15,000
Maintane.......................................................	25,000	x	.2	=	5,000
Winterizer......................................................	25,000	x	.2	=	5,000
					25,000

	Sales Price per lb.		Selling Cost/lb. (20% of Sales Price)		Net Realizable Value per lb.		Number of Lbs.		Total NRV
Greenup.........................................................		$12.00				$2.40				$9.60				15,000			$144,000
Maintane.......................................................		10.50				2.10				8.40				5,000			42,000
Winterizer......................................................		11.90				2.38				9.52				5,000			47,600
																	$233,600

      Allocated cost per lb. of Greenup

=	$130,000	x	($144,000 ÷ $233,600)	÷	15,000 lbs.
=	$5.34

      Allocated cost per lb. of Maintane

=	$130,000	x	($42,000 ÷ $233,600)	÷	5,000 lbs.
=	$4.67

      Allocated cost pound lb. of Winterizer

=	$130,000	x	($47,600 ÷ $233,600)	÷	5,000 lbs.
=	$5.30

c.   The profit under current production schedule A is:

Total net realizable value	=	$233,600	(from b above)
Less joint costs incurred		130,000
		$103,600

      Outputs under alternative production schedule B:

Product		Output Mix		Unit kwh Usage		Usage per100 Lbs. of Input
Greenup		50	%	34			1,700
Maintane		10		26			260
Winterizer		40		42			1,680
							3,640

Pounds of input processed =	850,000 kwh	= 23,352 pounds
3,640 kwh per hundred pounds

Amount of Greenup produced	=	23,352	x	.5	=	11,676
Amount of Maintane produced	=	23,352	x	.1	=	2,335
Amount of Winterizer produced	=	23,352	x	.4	=	9,341
						23,352

      The margin under alternate production schedule B is:

      ($9.60 x 11,676) + ($8.40 x 2,335) + ($9.52 x 9,341 ) – ($1.80 x 23,352) – $85,000

      = $112,089.60 + $19,614 + $88,926.32 – $42,033.60 – $85,000 = $93,596.32

      Therefore, current production schedule A yields a higher operating profit of $103,600 versus $93,596.32 for schedule B.