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 $1.20 a pound to make, and it has a selling price of $7.40 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	$	0.60
Direct labor		1.36
Total direct cost	$	1.96

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	$	3,000
Depreciation of mixing equipment	$	1,500

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 6,500 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 $3,000 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:

1. How much incremental revenue does the company earn per jar of polish by further processing Grit 337 rather than selling it as a cleaning powder? (Round your answer to 2 decimal places.)

2. How much incremental contribution margin does the company earn per jar of polish by further processing Grit 337 rather than selling it as a cleaning powder? (Round your intermediate calculations and final answer to 2 decimal places.)

3. How many jars of silver polish must be sold each month to exactly offset the avoidable fixed costs incurred to produce and sell the polish? (Round your intermediate calculations to 2 decimal places.)

4. If the company sells 8,900 jars of polish, what is the financial advantage (disadvantage) of choosing to further process Grit 337 rather than selling is as a cleaning powder? (Enter any "disadvantages" as a negative value. Round your intermediate calculations to 2 decimal places.)

5. If the company sells 11,200 jars of polish, what is the financial advantage (disadvantage) of choosing to further process Grit 337 rather than selling is as a cleaning powder? (Enter any "disadvantages" as a negative value. Round your intermediate calculations to 2 decimal places.)

Answer 1

(1) Revenue per Jar of Polish = $5

Loss of Revenue per jar of Polish = $7.40 / 4 i.e. 1.85

Incremental revenue per jar of polish = $5 - $1.85 = $3.15

(2) Contribution lost per jar of polish = ($7.40 -$1.20) / 4 i.e. 1.55

Contribution per jar of polish = Selling price - Variable selling expense - material cost - labor cost - variable overhead - proportionate cost of Grit 337

= $5 - ($0.25 + $0.60 + $1.36 + $0.34 + $0.30)

= $2.15

Incremental Contribution margin = $2.15 - $1.55 i.e. $0.60

(3) Avoidable fixed costs = Production Supervision + Advertising Cost

= $3,000 + $3,000

= $6,000

No of jars to be sold = Avoidable fixed cost / Contribution per jar

= $6,000 / $2.15

= 2,790.69 i.e. 2,791 jars

(4) Financial Advantage/(Disadvantage) of selling 8,900 jars  = Incremental Contribution From 8,900 jars - Avoidable fixed costs

   = ($0.6 * 8,900) - $6,000

= $5,340 - $6,000

= -$660 i.e. financial disadvantage of $660

(5) Financial Advantage/(Disadvantage) of selling 11,200 jars  = Incremental Contribution From 8,900 jars - Avoidable fixed costs

= ($0.6 * 11,200) - $6,000

= $6,720 - $6,000

= $720 i.e. financial advantage of $720