Question

Cotopaxi makes backpacks. Traditionally, they bought fabric in quantity, and cut out the forms for their backpacks from large pieces, discarding the interstitial material as scrap. Due to the integrated nature of the production facility, the cost of all this fabric was considered a joint cost, allocated by the approximate relative sales value method, and the scraps were considered a waste by-product. Recently however, an enterprising employee had the great idea to use these scraps and make small, unique bags from the heretofore-discarded pieces of fabric. The company agreed to implement this idea on a trial basis, and the accounting department decided to consider these bags a by-product using the net realizable value method. The marketing department set the price for the by-product bags at $50, and in the first year of production, 10,000 of these scrap bags were sold. At the end of the first year, the accounting department determined that each bag incurred an additional processing cost of $40 on average in additional materials (straps, buckles, thread, etc.), labor, and variable overhead (not including the cost of the scrap fabric from whence they came).   

How much additional income does selling the by-product bags earn Cotopaxi (per bag)?

-$40 per bag (loss)

$0 per bag

$10 per bag

$40 per bag

$50 per bag

What is the amount of Joint Cost, under the Net Realizable Value method, that will be allocated to each by-product bag?

-$40 of Joint Cost per bag

$0 of Joint Cost per bag

$10 of Joint Cost per bag

$40 of Joint Cost per bag

$50 of Joint Cost per bag

Given your answers to the two previous questions, and recalling that Cotopaxi uses the net realizable value method to account for the by-product bags, how much profit per bag will be recognized by the by-product bag division?

-$40 per bag (loss)

$0 per bag

$10 per bag

$40 per bag

$50 per bag

Answer 1

Q1. Answer is $10 per bag

Explanation is as follows:

Selling price per bag;   $ 50 per bag

Less: Additional cost incurred per bag: $40 per bag

Addtional incocme generated per bag:   $10 per bag

Q2. Answer is $10 of Joint Cost per bag

Explanation is as follows:

The Joint cost allocated to bags is a net realizable value of bag which is selling price Less additional cost incurred in making the bag.

Therefore, Joint cost allocated to each bag: $ 10 per bag ($50 - $40 per bag)

Q3. Answer is $ 0 per bag

Explanation is as follows:

As per net realizable value, the profits per bag is computed as follows:

Selling price per bag:                                          $ 50 perr bag

Less: Additional cost material incurred per bag: $ 40 per bag

Less: Joiint cost allocated per bag:                     $10 per bag

Profit earned per bag:                                          $ 0 per bag

Note: As oer net relaizable value, the joiont cost is allocated to by product on the basis of net relaizable value (i.e. sales - incremental cost ). In such cases, the by prooduct will not generate any profit.