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).

What happened to the joint cost of fabric allocated to the main product lines when the new by-product bags were introduced?

Increased the joint costs allocated to the other products

Decreased the joint costs allocated to the other products

No change in joint costs allocated to the other products What did this new line of by-product bags do to the recognized profitability of Cotopaxi’s main backpack products? Increased the profitability of the main products Decreased the profitability of the main products No change in the profitability of the main products What did this new line of by-product bags do to the total profitability of Cotopaxi’s as a whole? (Note: assume the new bags only incurred the variable costs listed above) Increased overall profitability Decreased overall profitability No change to overall profitability If Cotopaxi had instead allocated the joint-cost of fabric using the physical units method, how would this affect their overall profitability for the company as a whole (compared to allocating by the approximate relative sales value method)? (Note: assume all produced products were sold) Increase profitability Decrease profitability No effect on profitability If Cotopaxi had instead accounted for the new bags as a full product instead of a by-product, how would this affect their overall profitability for the company as a whole (compared to considering the new bags a by-product)? (Note: assume all produced products were sold) Increase profitability Decrease profitability No effect on profitability In the first year of tests, some of the main-product line bag divisions decided to bundle the by-product bags with their sales. What should the manager of the by-product bags charge as the transfer price assuming the capacity to produce these by-product bags is effectively infinite (far greater than external market demand for the by-product bag)? $0 per bag $10 per bag $40 per bag $50 per bag After the first year, Cotopaxi realized that the demand for the by-product bags is so great that they cannot supply enough for both the direct market sales and as bundled products. What is the optimal transfer price that the by-product bag division should charge given this capacity constraint? $0 per bag $10 per bag $40 per bag $50 per bag

Answer 1