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 $7.80 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 $5.00 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		1.36
Total direct cost	$	1.86

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	$	1,400

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 2,500 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 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 8,700 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 11,000 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

1.Incremental revenue per jar of polish = 5-7.8/4

= $3.05

2.Calculation of Incremental contribution per jar:

Incremental revenue = $3.05

Less: Variable Costs

Other ingredients = $0.50

Direct labor = $1.36

Variable manufacturing overhead cost = 25%*1.36 = 0.34

Variable Selling costs = 5%*5 = $0.25

Incremental contribution margin per jar = $0.60

3.Let the jars be x

0.6x = 3,300+2,700

X = 10,000 jars

Hence, 10,000 jars must be sold each month to exactly offset the avoidable fixed costs incurred to produce and sell the polish

Note: Depreciation is a sunk cost and hence not avoidable, that’s why not considered

4.Contribution Margin = 8,700*0.6 = $5,220

Less: Fixed Costs = $6,000

financial advantage (disadvantage) of choosing to further process Grit 337 rather than selling is as a cleaning powder = -$780

i.e. disadvantage

5.Contribution Margin = 11,000*0.6 = $6,600

Less: Fixed Costs = $6,000

Financial Advantage = $600