Question

Gigabody, Inc., a nutritional supplement manufacturer, produces five lines of protein supplements. Each product line is managed separately by a senior-level product engineer who is evaluated, in part, based on his or her ability to keep costs low. The five product lines are produced in a joint production process. After splitting off from the joint production process, all five lines are processed further before resale.

Traditionally, joint product costs have been allocated to the five product lines using the physical units method. Recently, however, one of the line managers has complained that the supplement she oversees, the Turbo Capsule, is subsidizing the production of the Power Shake. As she puts it, "The powder for the Power Shake requires a higher temperature in the early refining process than the powder in my capsules, so it should carry more of the joint costs!" However, the line manager does not point out that in terms of the powder used, the Power Shakes sell for a fraction of the Turbo Capsules, such that Turbo Capsules have much higher margins than Power Shakes. This provides a reasonable argument for Turbo Capsules to carry even more of the joint costs than they currently carry.

Instructions

1. Did the line manager behave ethically by not disclosing the facts that go against her argument?

2. What factors should be considered when determining the allocation of joint costs?

Note: add citations when necessary.

Answer 1

Below are the methods available to allocate the Joint costs before split-off point:

A. Sales Value Method: Allocated based on the sales value of each product.

B. Physical Unit method: Allocated based on the physical units produced.

C. Average Unit Cost Method: Allocate based on the Average unit cost of each product.

D. Weighted Average Method: Allocated based on different weight factors such as Unit Size, Complexity & Price.

1. Did the line manager behave ethically by not disclosing the facts that go against her argument?

The method used in the company is the Physical unit method. Based on that method, irrespective of the process & complexity of producing each product, the cost would be allocated to products based on the physical units produced. Keep in mind that none of the methods to allocate joint costs is perfect. Each method has its own pros & cons. The company must select the method based on the applicability of the factors such as the process of producing each product.

The argument by the manager, "The powder for the Power Shake requires a higher temperature in the early refining process than the powder in my capsules, so it should carry more of the joint costs!", seems legit and reasonable. So, there are other options to go for allocation like Sales Value, Average Unit cost, or Weighted Average. In that suggestion, ideally, the manager should inform about the selling price of the products. So, the management can make a decision to change the method from the Physical Unit to Sales Volume. In isolation, the non-disclosure is not ethically incorrect. But if we want to have a holistic view it is unethical not to disclose that information.

2. What factors should be considered when determining the allocation of joint costs?

Below are the factors to be considered while deciding the method to be used to allocate the joint costs:

A. Is the process the same or different to produce each product?

B. Does that process require different activities per product?

C. Can we identify the different activities and assign costs to those activities?

D. Do we know the Sales Price of each product?

E. Do we know the unit cost of each product?

F. How easy or difficult it is to separate the activities & efforts to produce each product?

Now, based on these questions, the management can take a decision on the method to be selected.