Problem 1. Enron Chemical Company is a highly diversified chemical processing co

Question

Problem 1. Enron Chemical Company is a highly diversified chemical processing company. The company manufactures swimming pool chemicals, chemicals for metal processing companies, specialized chemical compounds for other companies and a full line of pesticides and insecticides. Currently, the New River plant is producing two derivatives, RNA-1 and RNA-2, from the chemical compound VDB developed by Enron’s research labs. Each week 1,200,000 pounds of VDB is processed at a cost of $246,000 into 800,000 pounds of RNA-1 and 400,000 pounds of RNA-2. The proportion of these two outputs is fixed and cannot be altered because this is a joint process. RNA-1 has no market value until it is converted into a product with the trade name Fastkil. The cost to process RNA-1 into Fastkil is $240,000. Fastkil wholesales at $50 per 100 pounds. RNA-2 is sold as is for $80 per hundred pounds. However, Enron has discovered that RNA-2 can be converted into two new products through further processing. The further processing would require the addition of 400,000 pounds of compound LST to the 400,000 pounds of RNA-2. The joint process would yield 400,000 pounds each of DMZ-3 and Pestrol—the two new products. The additional raw material and related processing costs of this joint process would be $120,000. DMZ-3 and Pestrol would each be sold for $57.50 per 100 pounds. Enron management has decided not to process RNA-2 further based on the analysis presented in the schedule below. Enron used the physical method to allocate the common costs arising from joint processing. Process Further______________________ _______________________________RNA-2______DMZ-3_______Pestrol____Total________ Production in pounds 400,000 400,000 400,000 Revenue $320,000 $230,000 $230,000 $460,000 Costs: VDB costs $ 82,000 $ 61,500 $ 61,500 $123,000 Additional raw materials (LST) And Processing of RNA-2 ---- 60,000 60,000 120,000 Total costs $ 82,000 $121,500 $121,500 $ 243,000 Weekly gross profit $238,000 $108,500 $108,500 $ 217,000 A new staff accountant who was to review the analysis above commented that it should be revised and stated. “Product costing of product such as these should be done on a net relative sales value basis not a physical volume basis.” REQUIRED: a. Discuss whether the use of the net relative sales value method would provide data more relevant for the decision to market DMZ-3 and Pestrol. b. Critique the Enron Company’s analysis and make any revisions that are necessary. Your critique and analysis should indicate 1) Whether the Enron Chemical Company made the correct decision. 2) The gross savings (loss) per week of Enron’s decision not to process RNA-2 further, if different from the company’s prepared analysis.

Explanation / Answer

a) The use of the net relative sales value method does not provide data more relevant for the decision to marketing. The Joint cost allocation is necessarily arbitrary and, although used for financial accounting purposes are irrelevant to this decision because costs are incurred in both cases.The Enron Company should calculate the differential profit of its alternate choices by comparing the differential revenues and differential costs. b) Revenue from further processing of RNA-2 Pestrol (400,000 × ($57.50 ÷ 100 per pound)) $230,000 DMZ-3 (400,000 × ($57.50 ÷ 100 per pound)) $230,000 Total revenue from further processing $460,000 Less revenue from sale of RNA-2 -$320,000 Differential revenue $140,000 Differential Cost (VDB cost are irrelevant , not included -$120,000 Differential Profit $20,000 The Enron Chemical Company made the incorrect decision because it includes allocated portions of the joint cost of VDB.The VDB cost is irrelavant and its arbitrary decision to market DMZ-3 and Pestrol. The Enron’s decision not to process RNA-2 further, is incorrect as decision results in a loss of $20,000 in profit per week,as indicated by the analysis above.

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