Question

Michigan Timber uses a joint process to manufacture two grades of wood: A and B. During October 2010, the company incurred $12,000,000 of joint production cost in producing 18,000,000 board feet of Grade A and 6,000,000 board feet of Grade B lumber. Th e company allocates joint cost on the basis of board feet of lumber produced. Th e company can sell Grade A lumber at the split-off point for $0.80 per board foot. Alternatively, Grade A lumber can be further processed at a cost of $0.75 per board foot and then sold for $1.90 per board foot. No opportunity exists for processing Grade B lumber after split-off.

a. How much joint cost should be allocated to Grade A and to Grade B lumber?

b. If Grade A lumber is processed further and then sold, what is the incremental effect on Michigan Timber’s net income? Should the additional processing be performed?

Answer 1

a. Allocation rate = $24,000,000 ÷ 48,000,000 feet = $0.50 per foot

 

Grade A:  $0.50 x 36,000,000 =  $18,000,000

Grade B:  $0.50 x 12,000,000 =  $  6,000,000

 

b. Incremental revenue (36,000,000 x $1.10)   $39,600,000

Incremental costs (36,000,000 x $0.75)           (27,000,000)

Increase in income                                               $12,600,000

Based on the incremental change in net income, the company should process grade A wood further.

a. Grade A:  $0.50 x 36,000,000 =  $18,000,000

 

Grade B:  $0.50 x 12,000,000 =  $  6,000,000

 

b. Based on the incremental change in net income, the company should process grade A wood further.