PPT 7 -1

Don R. Hansen

Maryanne M. Mowen

COST MANAGEMENT

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Joint Product and By-Product

Costing

Chapter Seven

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Learning Objectives

Identify the characteristics of the joint production process.

Allocate joint product costs according to benefits-received approaches and the relative market value approaches.

Describe methods of accounting for by-products.

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Learning Objectives (continued)

Explain why joint cost allocations may be misleading in management decision making.

Discuss why joint production is seldom found in service industries.

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Joint Production Process

Raw Material:

HogProcessing

Hides

Pork Meat

Split-Off

Point

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Independent Multiple-Product Production

Raw Material:

Steel

Processing Taurus

MustangProcessing

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Joint Production Process

Joint products are two or more products produced simultaneously by the same process up to a “split-off” point.

The split-off point is the point at which the joint products become separate and identifiable.

Separable costs are easily traced to individual products and offer no particular problem.

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Joint Costs

Joint Production Costs(Manufacturing perfume)

Processing

$400,000

Processing

$100,000

Processing

$300,000

(Flower Oil)

Charm:

10,000 ounces

@ $40 per ounce

Wild Scent:

20,000 ounces

@ $10 per ounce

Wild Flower:

50,000 ounces

@ $1 per ounce

Separable

Costs

Oil

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Characteristics

By-Product Costs

By-product resulting from scrap, trimmings, and so forth, of the main products in essentially nonjoint-product types of undertakings (e.g., fabric trimmings from clothing pieces).

Scrap and other residue from essentially joint-product types of processes (e.g., fat trimmed from beef carcasses).

A minor joint product situation (fruit skins and trimmings used as animal feed).

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By-Products

The distinction between joint and by-products rests solely on the relative importance of their sales value.

A by-product is a secondary product recovered in the course of manufacturing a primary product.

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Examples of Joint Products and By-Products

Industry Joint Products and By-products

Agriculture and Food Industries

Flour milling Patent flour, clear flour, middlings,bran, and wheatgem

Extractive Industries

Copper mining Copper, gold, silver, and other metals

Chemical Industries

Soap making Soap and glycerine

Manufacturing

Cement Concrete pipe and aggregate

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Methods

Accounting For Joint Product Costs

Benefits-Received Approaches

Physical Units Method

Weighted Average Method

Allocation Based on Relative Market Value

Sales-Value-at-Split-Off-Method

Net Realizable Value Method

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An Example:

Suppose that a sawmill processes logs into four grades of lumber totaling 3,000,000 board feet as follows.

Board Weight Price at Split-OffGrades Feet Factor (per 1,000 ft.)

1 450,000 1.30 $300

2 1,200,000 1.10 200

3 600,000 1.00 121

4 750,000 .50 70

Total 3,000,000=======

Total joint cost is $186,000

Joint Costs Example

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Board Joint CostGrades Feet % of Units Allocation

1 450,000 .15 $ 27,900

2 1,200,000 .40 74,400

3 600,000 .20 37,200

4 750,000 .25 46,500

Total 3,000,000 $186,000======= =======

The Physical Units Method

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Board Weight Weighted # AllocatedGrades Feet Factor of Board Feet Percent Joint Cost

1 450,000 1.30 585,000 .2031 $ 37,776

2 1,200,000 1.10 1,320,000 .4583 85,244

3 600,000 1.00 600,000 .2083 38,744

4 750,000 .50 375,000 .1302 24,217

Totals 3,000,000 2,880,000 100.00 *$186,000======= ======= ===== =======

* Rounding Error

Grades with higher weights require more cost to obtain the required finish and quality appearance.

Weighted Average Method

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Board Price at Sales Value AllocatedGrades Feet Split-Off at Split-off Percent Joint Cost

1 450,000 $300 $135,000 .2699 $ 50.201

2 1,200,000 200 240,000 .4799 89,261

3 600,000 121 72,600 .1452 27,007

4 750,000 70 52,500 .1050 19,530

Totals 3,000,000 $500,100 100.00 *$186,000======= ====== ===== ======

*Rounding Error

Sales-Value-At-Split-off Method

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An Example:

Suppose that a company manufactures two products, Alpha and Beta, from a joint process. One production run costs $5,750 and results in 1,000 gallons of Alpha and 3,000 gallons of Beta. Neither product is salable at split-off, but must be further processed . The separable costs for Alpha is $1 per gallon and for Beta is $2 per gallon. The eventual market price for Alpha is $5 and for Beta $4.

Further Hypothetical Hypothetical

Market Processing Market Number Market Allocated

Price Cost Price of Units Value Joint Cost

Alpha $5 $1 $4 1,000 $4,000 $2,300

Beta 4 2 2 3,000 6,000 3,450

$10,000 $5,750

Net Realizable Value Method

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Using data from the previous example:

Revenue [($5 x 1,000) + ($4 x 3,000)] $17,000 100 %

Costs [$5,750 + ($1 x 1,000) + ($2 x 3,000)] 12,750 75

Gross profit $ 4,250 25 %Eventual market value $5,000 $12,000

Less: Gross margin @ 25% 1,250 3,000

Cost of goods sold $3,750 $ 9,000

Less: Separable costs 1,000 6,000

Allocated joint costs $2,750 $ 3,000

===== =====

Alpha Beta

Constant Gross MarginPercentage Method

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Assume that $1,000,000 of joint cost was allocated to five products based on the sales-to-production ratio.

Note that under this method, less cost is assigned to slower moving goods like Product C, which accounted

for 25% of production by only 15% of sales. A good like Product B, which accounted for just 15% of

production but 20% of sales, receives relatively more joint cost. The end result is that relatively higher

production cost is matched against current revenues, and the company claims lower net income for tax

purposes. %of % of Sales-to-Production Cost Assigned Product

Total Sales Production Ratio Percent Sales/Prod.

A 10 10 1.0000 19.9338 $ 199,338

B 20 15 1.3333 26.5778 265,778

C 15 25 0 .6000 11.9603 119,603

D 40 30 1.3333 26.5778 265,778

E 15 20 0.7500 14.9504 149,504

100 100 5.0166 *100.000 $1,000,001

=== === ===== ====== ========

*Rounding error

Sales-To-Production-Ratio Method

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Given for a main product and a by-product:

Total manufacturing costs of main product and by-product $22,000

Total sales of main product 25,000

Estimated net realizable value of by-product produced 2,000

Beginning inventories (including ending inventory of by-product) None

Ending inventory of main product is 25% of production volume

Ending inventory of by-product is 10% of production volume

Accounting for By-Product Costs

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Sales of main product $25,000

Cost of goods sold:

Total manufacturing costs $22,000

Deduct net revenue of byproduct (90% x $2,000) 1,800

Net manufacturing costs $20,200

Deduct main product inventory (25% x 20,200) 5,050

Deduct byproduct inventory (10% x $2,000) 200 14,950

Gross margin $10,050

======By-product revenue is treated as a reduction of main product manufacturing costs.

Accounting for By-Product Costs(continued)

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Sales of main product $25,000

Add net revenue of byproduct (90% x $2,000) 1,800

Total Sales $26,800

Cost of goods sold:

Total manufacturing costs $22,000

Deduct main product inventory (25% x 22,000) 5,500

Deduct byproduct inventory (10% x $2,000) 200 16,300

Gross margin $10,500

======By-product revenue is treated as a separate revenue item.

Accounting for By-Product Costs(continued)

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Effect of Joint Product Costs on Cost Control and Decision Making

It is important to understand when the use of allocated joint product costs may be misleading.

In making decisions relative to jointly produced articles, it must be remembered that the products are necessarily produced jointly.

Some areas that can be affected by joint cost allocations are:

Output decisions

Further processing of joint products

Pricing jointly produced products

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End of Chapter 7