Dawson Corporation produces a product called Blocker, which gives rise to a by-product called Spotter. The only costs associated with Spotter are additional processing costs of $4 for each unit. Dawson accounts for Spotter's sales first by deducting its separable costs from its sales and then by deducting this net amount from the cost of sales of Blocker. This year, 9,600 units of Spotter were produced. They were all sold for $8 each. Company operating expenses were $250,000 for the year. Sales revenue and cost of goods sold for Blocker were $1,600,000 and $800,000, respectively. (CPA adapted)Required:(a) Calculate the company's gross margin under the current accounting method.(b) Assume the company changes its accounting method and accounts for the by-product's net realizable value as
"other revenue." Calculate the gross margin under the new method.(c) Under what circumstances would method (a) or (b) be preferred?
What will be an ideal response?
(a)
| Net Realizable Value of Spotter [($8 - $4) × 9,600] | $ | 38,400 | |
| Cost of Goods Sold of Blocker ($800,000 - $38,400) | $ | 761,600 | |
| Gross Margin of Blocker ($1,600,000 - $761,600) | $ | 838,400 |
| Sales$1,600,000 |
| Other Revenue 38,400 |
| Total Revenue$1,638,400 |
| Cost of Goods Sold 800,000 |
| Gross Margin$838,400 |
While either method will result in the same gross margin for the company, treating the net realizable value as other revenue is the simpler method. Technically, the matching principle is violated if all products are not sold in the accounting period. However, because the effect is normally considered immaterial, many companies use it. Deducting the net realizable value from the cost of the main products can be more complicated if all main products are not sold. If all the main products produced in the period have not been sold, the net realizable value of by-products should be prorated to the main product inventories and cost of goods sold.
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