Cost Allocation: Joint Products
and By-products
ACCT7320
Dr. Bailey
15 - 1
Nature of Cost Allocations
Pervasive in accounting
– Across time (depreciation)
– Between departments (e.g., service depts)
– To products, customers, branch offices, etc.
 Often arbitrary
– May mislead in decision making

15 - 2
Criteria to Guide
Cost-Allocation Decisions
Cause-and-effect:
Using this criterion, managers identify the
variable or variables that cause resources
to be consumed.
Benefits-received:
Using this criterion, managers identify the
beneficiaries of the outputs of the cost object.
15 - 3
Criteria to Guide
Cost-Allocation Decisions
Fairness or equity:
This criterion is often cited on government
contracts when cost allocations are the basis
for establishing a price satisfactory to the
government and its suppliers.
Ability to bear:
This criterion advocates allocating costs in proportion
to the cost object’s ability to bear them.
15 - 4
Role of Dominant Criteria
The cause-and-effect
and the benefitsreceived criteria
guide most
decisions related
to cost allocations.
Fairness and ability
to bear are less
frequently used.
Why?
15 - 5
Role of Dominant Criteria
Fairness is an especially difficult criterion
to obtain agreement on.
The ability to bear criterion raises issues
related to cross-subsidization across users
of resources in an organization.
15 - 6
Joint Costs
This “joint cost” problem arises when
companies inescapably produce two or more
products simultaneously out of the same
process.
 How do they allocate costs to jointly-produced
products.
 How are the resulting allocations useful?

15 - 7
Joint-Cost Basics
Joint costs are the costs of a single production
process that yields multiple products
simultaneously.
 Industries abound in which a single
production process simultaneously yields two
or more products.

15 - 8
Joint-Cost Basics
Tomatoes
Tomato juice
Tomato sauce
Tomato paste
15 - 9
Joint-Cost Basics
Coal
Gas
Benzol
Tar
15 - 10
Joint-Cost Basics

1
2
The outputs of a joint production process fall
into two general categories:
Joint products—those that the company is in
business to produce (higher total value)
By-products—those that also emerge (lesser
value)
15 - 11
Splitoff Point
The splitoff point is the juncture in the
production process where one or more
products in a joint-cost setting become
separately identifiable.
 Separable costs are all costs (manufacturing,
marketing, distribution, etc.) incurred beyond
the splitoff point that are assignable to one or
more individual products.

15 - 12
Joint Products and By-products
Joint products have relatively high sales value
at the splitoff point.
– Main product is the result of a joint
production process that yields only one
product with a relatively high sales value.
 By-products are incidental products resulting
from the processing of another product.

15 - 13
Joint Products and By-products
A by-product has a relatively low sales value
compared with a joint or main product.
– Revenue from byproducts generally reduces
the costs of the joint products. We aren’t
studying the details.
 Some outputs of the joint production process
have zero sales value.
– “Waste” can be ignored in accounting

15 - 14
Joint Products and By-products
Main or
By-products
Joint Products
High
Low
Sales Value
15 - 15
Joint Products and By-products
To reiterate: sales value determines the
classification
 Products can change from by-products to joint
products when their relative sales values
increases, and vive-versa
– Kerosene once main product of petroleum

15 - 16
Why Allocate Joint Product Costs?

1
The purposes for allocating joint costs to products
include:
Inventory costing
– Important for financial accounting purposes, reports to income tax
authorities, and internal reporting purposes.
2
Cost reimbursement contracts
– Cost allocation is required for cost reimbursement purposes under
contracts when only a portion of a business’ products or services is
sold or delivered to a single customer (government agency).
15 - 17
Why Allocate Joint Product Costs?
3
Insurance settlements
» Require cost allocation when damage/loss claims made
by manufacturer: What was the “cost”?
4
Rate regulation
» If one or more of the jointly produced products or
services are subject to price regulation (nat. gas).
5.
Litigation
» Joint cost allocation is important in litigation
involving one or more joint products.
15 - 18
How to Allocate Joint Costs?

The two basic approaches to allocating joint
costs are:
– Use market-based data such as relative
product revenues.
» “Sales value at splitoff”
» “Estimated net realizable value”
– Use physical measures such as weight or
volume.
15 - 19
Allocating Joint Costs
Lubbock Company incurred $200,000 of joint
costs to produce the following:
 Product A: 10,000 units, 20,000 pounds
 Product B: 10,500 units, 48,000 pounds
 Product C: 11,500 units, 12,000 pounds

15 - 20
Sales Value at Splitoff Method

Allocates joint costs to joint products on the
basis of the relative total sales value at the
splitoff point.
– All outputs must have sales values at this
point to use the method.
15 - 21
Sales Value at Splitoff Method






Assume the following sales values per unit: A: $10.00, B:
$30.00, and C: $20.00
What is the total sales value at splitoff point?
Product A: 10,000 × $10.00 =
$100,000
15.5%
Product B: 10,500 × $30.00 =
315,000
48.8%
Product C: 11,500 × $20.00 =
230,000
35.7%
Total
$645,000
100%
15 - 22
Sales Value at Splitoff Method
How much joint costs are allocated to each
product?
 A: 15.5%× $200,000 = $ 31,008
 B: 48.8% × $200,000 = 97,674
 C: 35.7% × $200,000 = 71,318
 Total
$200,000

15 - 23
Sales Value at Splitoff Method
What are the joint production costs per unit?
 Product A: $31,008 ÷ 10,000 = $3.10
 Product B: $97,674 ÷ 10,500 = $9.30
 Product C: $71,318 ÷ 11,500 = $6.20

15 - 24
Sales Value at Splitoff Method
Assume all of the units produced of B and C
were sold (no further processing).
 2,500 units of A (25%) remain in inventory.
 What is the gross margin percentage of each
product?

15 - 25
Sales Value at Splitoff Method
Product A
 Revenues: 7,500 units × $10.00
 Cost of goods sold:
– Joint product costs $31,008
– Less ending inventory 7,752*

$75,000
23,256
» *$31,008 × 25%

Gross margin
$51,744
15 - 26
Sales Value at Splitoff Method



Prod. A: $75,000 – $ 23,256 = $51,744;
$51,744 ÷ $75,000 = 69%
Prod. B: ($315,000 – $97,674) ÷ $315,000 = 69%
Prod. C: ($230,000 – $71,318) ÷ $230,000 = 69%
The sales value at splitoff method
produces an identical gross margin
percentage for each product.
15 - 27
Estimated Net Realizable Value
(NRV) Method

Often products are processed further beyond
the splitoff point to make them marketable or
increase their value.
15 - 28
Estimated Net Realizable Value
(NRV) Method
The estimated NRV method allocates joint
costs to joint products on the basis of the
relative estimated NRV.
 NRV = (expected final sales value in the
ordinary course of business) – (expected
separable costs of the total production of
these products)

15 - 29
Absolute Irrelevance of Joint
Costs for Decision Making

Joint costs incurred up to the splitoff point are
past (sunk) costs irrelevant to the decision to
sell a joint (or main) product at the splitoff
point or to process it further.
15 - 30
Irrelevance of Joint Costs for
Decision Making
Assume that products A, B, and C can be sold
at the splitoff point (at price1) or processed
further into A1, B1, and C1 and sold at price2.
 Units
price1
price2
Add’l costs
10,000 A: $10
A1: $12 $35,000
10,500 B: $30
B1: $33 $46,500
11,500 C: $20
C1: $21 $51,500

15 - 31
Irrelevance of Joint Costs for
Decision Making
Should A, B, or C be sold at the splitoff
point or processed further?
 Product A: Incremental revenue $20,000
– Incremental cost $35,000 = ($15,000)
 Product B: Incremental revenue $31,500
– Incremental cost $46,500 = ($15,000)
 Product C: Incremental revenue $11,500
– Incremental cost $51,500 = ($40,000)

15 - 32
Irrelevance of Joint Costs for
Decision Making
Products A, B, and C should be sold at the
splitoff point.
 No techniques for allocating joint-product
costs can guide decisions about whether a
product should be sold at the splitoff point or
processed beyond splitoff.

15 - 33
The End
15 - 34