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Cost Accounting Horngreen, Datar, Foster
Cost Allocation: Joint Products and Byproducts
Cost Accounting Horngreen, Datar, Foster
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
Cost Accounting Horngreen, Datar, Foster
Joint Cost Terminology
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
Cost Accounting Horngreen, Datar, Foster
Joint Cost Terminology
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
Cost Accounting Horngreen, Datar, Foster
Joint Process Flowchart
Single Production Process
Joint Product #1
Byproduct
Joint Product #2
Steam: An Output with Zero Sales Value
Cost Accounting Horngreen, Datar, Foster
Reasons for Allocating Joint Costs
Required for GAAP and taxation purposesCost values may be used for evaluation purposesCost-based contractingInsurance settlementsRequired by regulatorsLitigation
Cost Accounting Horngreen, Datar, Foster
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
Cost Accounting Horngreen, Datar, Foster
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$
Cost Accounting Horngreen, Datar, Foster
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
Cost Accounting Horngreen, Datar, Foster
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
Cost Accounting Horngreen, Datar, Foster
NRV Example
Cream Skim-milk TotalFinal Sales Value of Production
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$
Cost Accounting Horngreen, Datar, Foster
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
Cost Accounting Horngreen, Datar, Foster
Constant Gross Margin NRV Method Example
Cream Skim-milk TotalFinal Sales Value of Production
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
Cost Accounting Horngreen, Datar, Foster
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
Cost Accounting Horngreen, Datar, Foster
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
Cost Accounting Horngreen, Datar, Foster
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
Cost Accounting Horngreen, Datar, Foster
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
Cost Accounting Horngreen, Datar, Foster
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
Cost Accounting Horngreen, Datar, Foster
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
Cost Accounting Horngreen, Datar, Foster
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
Cost Accounting Horngreen, Datar, Foster
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.
Cost Accounting Horngreen, Datar, Foster
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