Question

Larry, Inc. produces two products that are purchased and consumed by upscale high-end gourmets. Larry harvests rotten-log fungi which grow in Larry’s rotten-log lot in the middle of the forest. The fungi are processed into pre-goop and pre-slop which are identified at the split off point and can be sold for $50 and $60 per pound, respectively. The joint costs are $360,000, and the joint process yielded 5,000 pounds of Goop and 3,000 pounds of Slop.

It costs $15 per pound to process pre-goop into Goop which sells for $60 per pound, and it costs $20 per pound to process pre-slop into Slop which sells for $90 per pound. Assume that there is the same weight of pre-goop and pre-slop as the finished products Goop and Slop.

Required:

1. To maximize profit, which product should be processed further and then sold? Which product should be sold at the split-off point? Show your work.

      

2. What amount of joint costs will be allocated to each product if the sales value at split off method is used?

3. The current joint costs of $360,000 consists of $120,000 fixed and $240,000 variable costs. The new environmental regulation will increase the joint cost in the next year by $80,000, which are all fixed. Does it affect your decision made in 1)?

Answer 1

1

	GOOP	SLOP
SELLING PRICE PER POUND	$60	$90
UNITS PRODUCED	5,000	3,000
TOTAL SALES VALUE (A)	300,000	270,000
LESS
JOINT COST ALLOCATION (NOTE 1)	225,000	135,000
COST TO PROCESS PRE-GOOP TO GOOP ($15*5,000)	75,000	-
COST TO PROCESS PRE-SLOP TO SLOP ($20*3,000)	-	60,000
TOTAL COST (B)	300,000	195,000
PROFIT (A) - (B)	-	75,000

To maximize profit, Pre-Slop should be processed further and then sold.

Pre-Goop should be sold at $50 at the split-off point.

NOTES

1) Total joint cost = $360,000

Total units produced = 5,000 + 3,000 = 8,000

Joint Cost for Goop = (360,000 * 5,000) / 8,000 = 225,000

Joint Cost for Slop = (360,000 * 3,000) / 8,000 = 135,000

2. Sales value at split off method

Total joint cost = $360,000

Sales value of Goop = $300,000

Sales value of Slop = $270,000

Total Sales value = $570,000

Joint Cost for Goop = (360,000 * 300,000) / 570,000 = $189,474

Joint Cost for Slop = (360,000 * 270,000) / 570,000 = $170,526

3.

	GOOP	SLOP
SELLING PRICE PER POUND	$60	$90
UNITS PRODUCED	5,000	3,000
TOTAL SALES VALUE (A)	300,000	270,000
LESS
JOINT COST ALLOCATION (NOTE 2)	275,000	165,000
COST TO PROCESS PRE-GOOP TO GOOP ($15*5,000)	75,000	-
COST TO PROCESS PRE-SLOP TO SLOP ($20*3,000)	-	60,000
TOTAL COST (B)	350,000	225,000
PROFIT (A) - (B)	(50,000)	45,000

Increases in joint cost does not affect the answer as the profit will maximize only if we sell Pre-Slop after processing. Though there has been decrease in profit amounting $30,000 (75,000 - 45,000).

NOTES

1) Joint cost = $360,000

Additional joint cost = $80,000

Total joint cost = $440,000

Total units produced = 5,000 + 3,000 = 8,000

Joint Cost for Goop = (440,000 * 5,000) / 8,000 = 275,000

Joint Cost for Slop = (440,000 * 3,000) / 8,000 = 165,000