Question

King Industries produces various industrial chemicals. It costs $125,000 in joint processing costs to produce ChemA and ChemB

 standard production run generates 55,000 gallons of ChemA and 25,000 gallons of ChemB.

* ChemA sells for $5 per gallon. ChemB sells for $8 per gallon.

 For an additional $12,950, King further processes ChemA into ChemA+. The 50,000 gallons of ChemA+ produced are sold for $7 gallon. (Kings loses some volume in the process.)

 King also mixes some additional chemicals with ChemB to create SuperChem. It costs an additional $162,050 to generate 40,000 gallons of SuperChem. (The additional gallons come from the added-in chemicals. HINT: Don’t get distracted by this. The total gallons King can sell is 40,000.) King sells SuperChem for $9 per gallon

a. How should the $125,000 of joint product costs be allocated under the Net Realizable Value Method? (Remember, King is currently selling ChemA+ and SuperChem.)

b. Based on profitability only, should King continue to produce ChemA+ or start selling ChemA at the split-off point? What about SuperChem? Should the company continue to produce SuperChem or start selling ChemB?

Answer 1

a.Net Realizable Value = Sales Value –Additional Processing Costs

ChemA+ = 50,000*7 – 12,950

= $337,050

SuperChem = 40,000*9 – 162,050 = $197,950

Hence, joint cost allocation shall be as follows:

ChemA+ = 125,000*337,050/535,000 = $78,750

SuperChem = 125,000*197,950/535,000 = $46,250

b.Joint costs are sunk cost already incurred and hence not relevant for this decision

NRV of ChemA+ = $337,050

At Split off point = 55,000*5 =$275,000

Since value after processing is more, It should be processed further i.e. ChemA+

NRV of SuperChem = $197,950

At split off point = 25,000*8 = $200,000

The company should start selling ChemB since value at split off point is more