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 $6.60 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	$	0.55
Direct labor		1.48
Total direct cost	$	2.03

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	$	3,200
Depreciation of mixing equipment	$	1,600

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 4,500 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 $3,800 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?

If the company sells 11,700 jars of polish, what is the financial advantage (disadvantage) of choosing to further process Grit 337 rather than selling is as a cleaning powde

Answer 1

Financial advantage: $1190

Incremental revenue per jar:
Selling price of silver polish (per jar)	$            5.00
Selling price of Grit 337 (1/4 pound) ($6.60 x 1/4)	$            1.65
Incremental revenue per jar	$            3.35
Incremental variable costs per jar:
Other ingredients	$            0.55
Direct labor	$            1.48
Variable manufacturing overhead cost ($1.48 x 25%)	$            0.37
Variable selling costs (5% x $5)	$            0.25
Incremental variable costs per jar	$            2.65
Incremental contribution margin	$            0.70
Number of jars of silver polish sold	11700
Total incremental contribution	$   8,190.00
Less: Avoidable fixed costs	$   7,000.00
Financial advantage (disadvantage) $	$   1,190.00

Note: The cost of $1.60 per pound required to make Grit 337 is irrelevant since the same is incurred irrespective of whether Grit 337 is sold as a cleaning powder or is processed further into silver polish.

If the processing of Grit 337 into silver polish is discontinued, the production supervisor's salary of $3200 and advertising expense of $3800 would be avoided. Thus, the total avoidable fixed costs would be $7000.