Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 49

Cost Allocation; Equal Gross Margin Percentage; New Method Ted Brown is the chief financial officer of Haywood Inc., a large manufacturer of cosmetics and other personal care products. Ted is conducting a financial analysis of the firm's line of hand lotions which consists of three prod­ucts: Skin Salve, Skin Cream, and Skin Balm. Total sales for the three products in the recent year were $400,000, $250,000 and $500,000, respectively. Because there is a small amount of additional processing cost for each of the three products, which differs between the products ($20,000, $50,000 and $30,000, respectively), Ted has been using the net realizable value method for allocating the joint production cost of $500,000. However, he is not satisfied with the result of somewhat different gross margin percentage ratios (gross margin/sales) for the three products when using this approach. He knows only of the physical units method, the sales value at split-off method, and the net realizable value method for allocating joint cost.

Required Devise a new method of cost allocation for Ted so that after allocation of joint costs and separa­ble costs, the gross margin percentage is the same for all three products.

Step 1 of 3

Significance of cost allocation:

1. It motivates the management personnel to give more efforts in achieving goal of the organisation

2. Managers should me by incentivised properly for making decisions that are consistent with the goals of top management.

3. It is used to determine the rewards that should be awarded to managers for their efforts and skills in decision making.