Question

Prescott Lumber processes logs into grade A and grade B lumber. Logs cost $21,200 per load. The milling process produces 5,000 units of grade A with a market value of $72,800, and 15,000 units of grade B with a market value of $10,400. The cost of the milling process is $12,000 per load.

Required:

a. If the costs of the logs and the milling process are allocated on the basis of units of output, what cost will be assigned to each product?

	Cost Allocation Grade A Grade B

b. If the costs of the logs and the milling process are allocated on the basis of the net realizable value, what cost will be assigned to each product?

	Cost Allocation Grade A Grade B

c-1. How much profit or loss does the grade B lumber provide using the data in this problem and your analysis in requirement (a)?

c-2. Is it really possible to determine which product is more profitable?

Answer 1

a) To calculate the cost assigned to Grade A and Grade B lumber on the basis of units sold,

First add the total units produced Grade A and B = 5000+15000 =20000

Grade A = 5000/20000=25% of total Units

Grade B =15000/20000 =75% of total units

Total costs = 21200+12000 = 33200

Cost allocated to Grade A = 33200 * 25% = 8300

Cost allocated to Grade B = 33200 * 75% = 24900

b) Cost allocation on the basis of net realizable value.

Total market value of Grade A and B = 72800+10400 = 83200

Grade A =10400/83200 =87.5%

Grade B =10400/83200 = 12.5%

Grade A cost allocation = 33200 * 87.5% = 29050

Grade B cost allocation = 33200 * 12.5% = 4150

c-1) On the basis of cost allocated to the unit sold the cost allocated to grade B is 24900

So there is a loss = 10400-24900 = (14500)

c-2) It is difficult to determine which product is more profitable. Both the method gives us extreme values. It is clear from question b, we got profit when we used the net realization method and loss in the other method. It will be possible to determine the profit or loss, if we have more information regarding further process expenses incurred.