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Cost Accounting Horngreen, Datar, Foster

Cost Allocation: Joint Products and Byproducts


Joint Cost Terminology

Joint Costs:

costs of a single production process that yields multiple products simultaneously

Splitoff Point:

the place in a joint production process where two or more products become separately identifiable

Separable Costs:

all costs incurred beyond the splitoff point that are assignable to each of the now-identifiable specific products



Categories of Joint Process Outputs:1. Outputs with a positive sales value2. Outputs with a zero sales value

Product: any output with a positive sales value, or an output that enables a firm to avoid incurring costs• Value can be high or low



Joint Products: outputs of a joint production process that yields two or more

products with a high sales value compared to the sales values ofany other outputs

Main Product: output of a joint production process that yields one product with a

high sales value compared to the sales values of the other outputs

Byproducts: outputs of a joint production process that have low sales values

compared to the sales values of the other outputs


Joint Process Flowchart

Single Production Process

Joint Product #1

Byproduct

Joint Product #2

Steam: An Output with Zero Sales Value


Reasons for Allocating Joint Costs

Required for GAAP and taxation purposesCost values may be used for evaluation purposesCost-based contractingInsurance settlementsRequired by regulatorsLitigation


Joint Cost Allocation Methods

Physical Measures• allocate using tangible attributes of the products, such as

pounds, gallons, barrels, etc.

Market-Based • allocate using market-derived data (dollars):1. Sales value at splitoff2. Net Realizable Value (NRV)3. Constant Gross-Margin percentage NRV


Physical-Measure Method

Allocates joint costs to joint products on the basis of the relative weight, volume, or other physical measure at the splitoff point of total production of the productsExample: two products arise out of one joint process costing $500

JointProduct % Joint Costs

Gallons of Total Volume Costs AllocatedCream 25 25% 500$ 125$ Skim-milk 75 75% 500 375 Total 100 100% 500$


Sales Value at Splitoff Method

Uses the sales value of the entire production of the accounting period to calculate allocation percentageIgnores inventories

Cream Skim-milk TotalFinal Sales Value of Production

Cream: 25 gals@ $50/gal $1,250Skim-milk: 75 gals@ $10/gal $ 750Total $ 2,000

Allocation Based on % of Total Sales (rounded) 62.5% 37.5%

Joint Costs ($500) Allocated:Joint Cost X Allocation % 321.5 187.5


Net Realizable Value Method

Applicable if products are further processed after the splitoff pointAllocates joint costs to joint products on the basis of relative NRV of total production of the joint productsNRV = Final Sales Value – Separable CostsImplicit Assumption: • All profit margin is attributable to the joint process• Non to the separable cost• Not always appropriate as profit is typically attributable to all

phases of production


NRV Example


Cream: 25 gals@ $50/gal $ 1,250Skim-milk: 75 gals@ $10/gal $ 750Total $ 2,000

Less: Separable Costs $ 900 $ 200 $ 1,100

NRV $ 350 $ 550 $ 900

NRV Weighting:Product NRV ÷ Total NRV 39% 61%

Joint Costs 500 500

Joint Costs AllocatedNRV Weighting X Joint Costs 194$ 305$


Constant Gross Margin

Allocates joint costs to joint products in a way that the overall gross-margin percentage is identical for the individual productsJoint Costs are calculated as a residual amountImplicit assumption:Joint products are a single product with a single aggregate

gross–margin percentage

Single ratio of cost to sales value is very unlikely to be observed in multi product firms


Constant Gross Margin NRV Method Example


Cream: 25 gals@ $50/gal $ 1,250Skim-milk: 75 gals@ $10/gal $ 750Total $ 2,000

Less: Separable Costs $ 1,100

NRV $ 900

Joint Costs $ 500

Gross Profit $ 400

Gross Profit % of Sales Value 20,0%

Cream Skim-milk Total

Sales Values $ 1,250 $ 750 $ 2,000

Less Gross Margin @ 20% $ 250 $ 150 $ 400

Total Product Costs $ 1,000 $ 600 $ 1,600

Less Separable Costs $ 900 $ 200 $ 1,100

Joint Costs Allocated $ 100 $ 400 $ 500


Method Selection

If selling price at splitoff is available, use the Sales Value at Splitoff MethodIf selling price at splitoff is not available, use the NRV MethodIf simplicity is the primary consideration, Physical-Measures Method or the Constant Gross-Margin Method could be usedPhysical-Measures Method might be used if costs are to be determined for pricing decision (avoid circulars)Despite this, some firms choose not to allocate joint costs at all


Relevant Costs I:Sell-or-Process Further Decisions

In Sell-or-Process Further decisions, joint costs are irrelevant. Joint Costs are sunk Joint products have been produced, and a prospective decision must be made: to sell immediately or process further and sell later Separable Costs need to be evaluated for relevance individuallyProcess-further is worthwhile if additional revenues exceed additional costs


Relevant Costs II:Performance evaluation and pricing

Performance evaluation:• Conflicts of interest might arise with regard to decision making on

further processing• Manager is evaluated based on e.g. profit • Extensive allocation of fixed costs due to further process decision

might render a generally favorable decision unfavorable from themanagers perspective

Pricing• Each way of allocating costs from joint production process is highly

subjective • Should not be used for pricing decisions• Moreover: Cost allocation might be based on prices


Byproducts

Outputs of a joint production process that have low sales values compare to the sales values of the other outputs

Two methods for accounting for byproducts:Production Method• recognizes byproduct inventory as it is created, and sales and costs

at the time of saleSales Method• recognizes no byproduct inventory, and recognizes only sales at the

time of sales: byproduct costs are not tracked separately


Accounting for Byproducts

Assume a firm produces a main product and a byproduct in a joint production processBoth products are not processed further after splitoff pointProduction costs for the whole process are $1,000Main product sells for $ 50, byproduct for $ 1

Beginning Inventory

Production

Sales

Ending Inventory

Main product 0 100 80 20 Byproduct 0 5 4 1


Profit and Loss Account Production versus Sales Method

Production Method Sales Method Revenues: Main Product 4,000 4,000 Byproduct - 4 Total revenues 4,000 4,004 Costs of goods sold : Total manufacturing costs 1,000 1,000 Deduct byproduct revenue -5 Net manufacturing cost 995 1,000 Deduct main product inventory 199 200 Cost of goods sold 796 800 Gross margin: 3,204 3,204 Gross margin percentage 0.801 0.8002 Inventoriable Costs (end of period) Main product 199 200 Byproduct 1


Sales Method versus Production Method

Production method• Recognizes byproduct in inventory in the period of production• Production costs equal to revenue from sales are allocated to

byproduct• Firm makes zero profit from byproduct

Sales Method• Does not recognize the byproduct in inventory in production period• No production costs are allocated to byproduct• Profit from byproduct= Sales from byproduct


True or False

All products yielded from joint product processing have some positive value to the firm. Joint processing costs are always relevant for pricing decisions of the final product.


Pick your Choice

Oily Slime buys Emils, which is produced until two products can be separated, Ems and Ils. The cost of processing Emils to the splitoff point is $50,000. When the products can be identified, the following information is available:

If the firm uses the Sales value at splitoff method, how much of the joint processing cost should be allocated to Ems? • $20,000• $25,000• $30,000• $50,000

Production Sales Value at SplitoffEms 20,000 units $ 5 Ils 25,000 units $ 6

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