The full costing method associates fixed manufacturing costs with units of production and the amount of fixed manufacturing cost offset against revenue varies with the relationship between the number of units produced and the number sold. If production temporarily exceeds unit sales, some fixed manufacturing costs are deferred to future periods, and responsibility margin will be higher than would be reported under variable costing. If fewer units are produced during the period than are sold, fixed costs deferred in prior periods are offset against current revenue as inventory is drawn down. Thus, responsibility margin reported for the current period will be lower than would result from variable costing.
Under variable costing, the level of production has no effect on responsibility margin, because all fixed manufacturing costs are offset against revenue as they are incurred, regardless of the level of production.
A manufacturing company typically has departments specializing in purchasing, production, sales, shipping, accounting, finance, and personnel. Production departments and sales departments often are further subdivided along different product lines or geographical areas. Many companies produce multiple products from common raw materials and a shared production process. In such manufacturing processes, two business issues arise. One is how to allocate joint cost among the various types of products manufactured. The second incremental type of decision is whether some types of products should be processed further to create an even more valuable finished good.
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Case Context:
Groton Company offered Craik Veneer Company $20 per thousand feet for 1 million feet per month of sound backs in 1/24-inch birch veneer for the next 12 months. The production manager did not want to accept the offer based on the argument that the cost of production per thousand feet is at least $24.44. He arrived at this figure by dividing the joint cost of the birch block in proportion with the number of faces and backs produced. So selling backs at $20 per thousand would not even cover the cost of the material. On the other hand, the sales manager countered the production manager’s argument and suggested that the proper procedure was to allocate cost of the block in proportion to the amounts for which the products are sold because the backs are not as valuable as the faces.
Problem Definition:
Should Craik Veneer Company accept Groton Company’s offer to of $20 per thousand feet of 1/24 -inch backs?
Framework
Evaluate Groton Company’s offer using both the production manager’s and the sales manager’s methods of allocating costs.
1. Production Manager’s Method of Cost Allocation
Weight Method
2. Sales Manager’s Method of Cost Allocation.
Sales Value Method
By-Product Costing Method
Analysis
Cost and Other Information
Craik Veneer is able to produce 18,000 surface feet of 1/24-inch veneer per 1,000 board feet cut which produces an average of 50% faces and 50% backs
Labor and factory overhead costs together averaged $24 per thousand surface feet of veneer.
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Labor and factory overhead costs through clipping averaged $20.25 per 1,000 surface feet of veneer and those for drying and later operations averaged $3.75
Selling costs averaged $4.
Selling price for 1/24-inch birch faces 84 inches to 98 inches long was $ 88 per thousand surface feet.
Price of backs fluctuated widely. A selling price of $25 per thousand feet led to the accumulation of heavy inventory of backs.
A. If Craik will follow the Production Manager’s method of allocating cost and set the selling price of backs at $ 25 per thousand:
Grade 1/24-inch Veneer in Feet Sales Revenue per 1000 feet Total Sales Revenue Joint Cost Per 1000 feet Total Cost of Raw Materials Labor and Overhead Costs Selling Costs Profit
Faces 9,000 $88 $792 $24.44 $219.96 $216 $36 320.04
Backs 9,000 $25 $225 $24.44 $219.96 $216 $36 246.96
18,000 $73.08
**Note however that these figures are also based on the assumption that the 9,000 backs are sold immediately after they are produced. This assumption does not exactly represent the facts given in the case as the $ 25 selling price leads to the accumulation of more inventories of backs.
B. If costs are allocated using the Sales Manager’s suggestions:
1. Sales Value Method
Grade 1/24-inch Veneer in Feet Sales Revenue per 1000 feet Total Sales Revenue Percent of Total Total Cost of Raw Materials Applicable to Each Labor and Overhead Costs Selling Costs Profit
Faces 9,000 $88 $792 81.5 $358.60 $216 $36 $181.40
Backs 9,000 $20 $180 18.5 $81.40 $216 $36 ($153.40)
18,000 100 $440 $72 $28.00
2. By-Product Method
Joint Costs is up to clipping $20.25
Product Sales Value Costs beyond Split-Off Sales Value – Costs Beyond Split-Off
Faces $792 182.25 $609.75
Backs $180 3.75×9=33.75 $146.25
Total Joint Costs for Faces and Backs
$20.25 x 18 = $364.50
Less: $146.25
$ 218.25
Total Costs Charged to Faces
Net Joint Cost $ 218.25
Block Cost $ 440
Selling Costs $ 72 -($4 x 18)
$ 730.25
Gross Revenue $ 792
Less Costs Charged to Faces 730.25
$ 61.75
Decision and Basic Justification
Given the analysis done on the different methods of allocating costs, the sales manager of Craik Veneer Company should accept Groton Company’s offer of $20 per thousand feet offer for the 1/24-inch backs.
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The calculations of revenues, costs and profits using the three types of cost allocation methods all yielded positive net values. Although the computation of profits using the Production Manager’s method (selling backs at $25 using weight method) gave the highest profit, the figures shown were based on the assumption that the 9,000 backs are sold and shipped as fast as they were produced, which was not the case because the price of backs is not stable and a selling price of $25 per thousand feet is not quite the price the market is willing to take. This is evidenced by the accumulation of heavy inventory of backs.
On the other hand, net profits remains positive whether the sales value or the by-product costing method was used for allocating cost.
