Case: Knight Ltd.

Company produces and sells the following products

Selling price Selling price

Product Unit
at split-off point ($) at additional processing ($)
A 200.000 17 25
B 30.000 13 17
C 25.000 8 12
D 20.000 10 -
E 75.000 14 20

Raw material costs $3.590.000 and other manufacturing expenses cost $547.000 in the
manufacturing process which is absorbed on the products on the basis of their “Net
Realisable Value”. The additional processing costs of A, B, C, and E are $1.250.000,
$150.000, $50.000, and $150.000 respectively. Fixed costs are $473.000.
You are required to PREPARE the following in respect of the coming year:
(a) Statement showing the income forecast of the company assuming that none of
its products are to be further processed.
(b) Statement showing the income forecast of the company assuming that
products A, B, C, and E are to be processed further.
Can you suggest any other production plan whereby the company can maximize
its profits? If yes, then submit a statement showing the income forecast arising out of
the adoption of that plan
(c) Knight Ltd. Company has been selling all of its products at the split-off point.
Selling any of the products after further processing will entail direct competition with
some major customers. What strategic factors does the firm need to consider in
deciding whether to process any of the products further?
Answer:
Working note:
Allocation of joint costs on the basis of Net Realisable Value method
Additional Net
Allocated
Product Sales value ($) processing Realisable
Cost ($)
cost ($) Value ($)
5.000.000
A 1.250.000 3.750.000 2.625.000
(200.000 units x $25)
510.000
B 150.000 360.000 252.000
(30.000 units x $17)
300.000
C 50.000 250.000 175.000
(25.000 units x $12)
200.000
D - 200.000 140.000
(20.000 units x $10)
1.500.000
E 150.000 1.350.000 945.000
(75.000 units x $20)

5.910.000 4.137.000

Total joint cost = Raw material cost + Manufacturing expenses

= $3.590.000 + $547.000 = $4.137.000
Allocated joint cost = (Total joint cost/Total net realisable value) x Net realisable value
of each product
Allocated joint cost for Product A= ($4.137.000/$5.910.000) x $3.750.000 =
$2.625.000
Allocated joint cost for Product B= ($4.137.000/$5.910.000) x $360.000 = $252.000
Allocated joint cost for Product C= ($4.137.000/$5.910.000) x $250.000 = $175.000
Allocated joint cost for Product D= ($4.137.000/$5.910.000) x $200.000 = $140.000
Allocated joint cost for Product E= ($4.137.000/$5.910.000) x $1.350.000 = $945.000
(a) Statement showing income forecast of the company assuming that none of its
products are further processed
Products
Total
A B C D E
3.400.000 390000 200.000 1.050.000
Sales 200.000
($17 x ($13 x ($10 x ($14 x 5.240.000
revenue ($8 x 25.000)
200.000) 30.000) 20.000) 75.000)

Less:
Allocated
Costs
2.625.000 252.000 175.000 140.000 945.000 4.137.000
(Refer to
Working
note)

775.000 138.000 25.000 60.000 105.000

Less:
Fixed 473.000
Cost

Profit 630.000

(b) Statement showing income forecast of the company: assuming that products A,
B, C, and E are futher processed (Refer to working note)
Product
Total
A B C D E
7.510.00
Sales Revenue 5.000.000 510.000 300.000 200.000 1.500.000
0
4.137.00
Allocated Cost 2.625.000 252.000 175.000 140.000 945.000
0
Additional 1.600.00
1.250.000 150.000 50.000 - 150.000
Processing Cost 0
Total Processing 5.737.00
3.875.000 402.000 225.000 140.000 1.095.000
Cost 0
1.773.00
Gross Profit 1.125.000 108.000 75.000 60.000 405.000
0
Fixed Cost 473.000
1.300.00
Profit
0

Total processing cost= Allocated Cost + Additional processing cost

Total processing cost for Product A= $2.625.000 + $1.250.000 =$3.875.000
Total processing cost for Product B= $252.000 + $150.000 =$402.000
Total processing cost for Product C= $175.000 + $50.000 =$225.000
Total processing cost for Product D= $140.000
Total processing cost for Product E= $945.000 + $150.000 =$1.095.000

Gross Profit = Sale revenue – Total processing cost

Gross Profit for product A= $5.000.000 - $3.875.000= $1.125.000
Gross Profit for product B= $510.000 - $402.000= $108.000
Gross Profit for product C= $300.000 - $225.000= $75.000
Gross Profit for product D= $200.000 - $140.000= $60.000
Gross Profit for product E= $1.500.000 - $1.095.000= $405.000

Profit= Gross Profit – Fixed Cost

=$1.773.000 - $473.000 = $1.300.00

Suggested production plan for maximizing profits:

On comparing the figures of excess of revenue over cost of manufacturing in the above
statements one observes that the concern is earning more after further processing of A,
C, and E products but is losing a sum of $30.000 in the case of product B (if it is
processed further). Hence the best production plan will be to sell A, C, and E after
further processing and B and D at the point of split off. The profit statement based on
this suggested production plan is as below
Profit statement based on suggested production plan
Product
Total
A B C D E

Sales Revenue 5.000.000 390.000 300.000 200.000 1.500.000 7.390.000

Allocated Cost 2.625.000 252.000 175.000 140.000 945.000 4.137.000

Additional
1.250.000 - 50.000 - 150.000 1.450.000
Processing Cost
 Total Processing
3.875.000 252.000 225.000 140.000 1.095.000 5.587.000
Cost

Gross Profit 1.125.000 138.000 75.000 60.000 405.000 1.803.000

Fixed Cost 473.000

Profit 1.330.000

Total processing cost = Allocated Costs + Additional processing cost

Total processing cost for product A= $2.625.000 + $1.250.000= $3.875.000
Total processing cost for product B= $252.000
Total processing cost for product C= $175.000 + $50.000= $225.000
Total processing cost for product D= $140.000
Total processing cost for product E= $945.000 + $150.000= $1.095.000

Gross Profit = Sales revenue - Total processing cost

Gross Profit for product A= $5.000.000 - $3.875.000 = $1.125.000
Gross Profit for product B= $390.000 - $252.000 = $138.000
Gross Profit for product C= $300.000 - $225.000 = $75.000
Gross Profit for product D= $200.000 - $140.000 = $60.000
Gross Profit for product E= $1.500.000 - $1.095.000 = $405.000

Profit= Gross Profit – Fixed Cost

= $1.803.000 - $473.000 = $1.330.000
Hence the profit of the company has increased by $30.000
(c) Knight Ltd. Company has been selling all of its products at the split-off point.
Selling any of the products after further processing will entail direct competition
with some major customers. What strategic factors does the firm need to consider
in deciding whether to process any of the products further?