Cost Allocation:
Joint Products and Byproducts
Cost Accounting
Horngreen, Datar, Foster
Joint Cost Terminology
ƒ Joint Costs:
costs of a single production process that yields
multiple products simultaneously
ƒ Splitoff Point:
the place in a joint production process where two
or more products become separately identifiable
ƒSeparable 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
ƒ Categories of Joint Process Outputs:
1. Outputs with a positive sales value
2. Outputs with a zero sales value
ƒ 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
ƒ Joint Products:
outputs of a joint production process that yields two or more
products with a high sales value compared to the sales values of
any other outputs
ƒ 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
ƒ 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
Steam:
An Output with Zero Sales Value
Joint Product #1
Single Production
Process
Joint Product #2
Byproduct
Cost Accounting
Horngreen, Datar, Foster
Reasons for Allocating Joint Costs
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Required for GAAP and taxation purposes
Cost values may be used for evaluation purposes
Cost-based contracting
Insurance settlements
Required by regulators
Litigation
Cost Accounting
Horngreen, Datar, Foster
Joint Cost Allocation Methods
ƒ Physical Measures
• allocate using tangible attributes of the products, such as
pounds, gallons, barrels, etc.
ƒ Market-Based
• allocate using market-derived data (dollars):
1. Sales value at splitoff
2. Net Realizable Value (NRV)
3. Constant Gross-Margin percentage NRV
Cost Accounting
Horngreen, Datar, Foster
Physical-Measure Method
ƒ 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 products
ƒ Example: two products arise out of one joint process
costing $500
Joint
Product %
Joint
Costs
Gallons of Total Volume Costs Allocated
Cream
25
25%
$ 500 $ 125
Skim-milk
75
75%
500
375
Total
100
100%
$ 500
Cost Accounting
Horngreen, Datar, Foster
Sales Value at Splitoff Method
ƒ Uses the sales value of the entire production of the
accounting period to calculate allocation percentage
ƒ Ignores inventories
Cream
Final Sales Value of Production
Cream: 25 gals@ $50/gal
Skim-milk: 75 gals@ $10/gal
Total
Skim-milk
$1,250
$ 750
$ 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
Total
Horngreen, Datar, Foster
Net Realizable Value Method
ƒ Applicable if products are further processed after the
splitoff point
ƒ Allocates joint costs to joint products on the basis of
relative NRV of total production of the joint products
ƒ NRV = Final Sales Value – Separable Costs
ƒ Implicit 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
Final Sales Value of Production
Cream: 25 gals@ $50/gal
Skim-milk: 75 gals@ $10/gal
Total
Total
$ 1,250
$ 750
$ 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
$ 194 $
305
Joint Costs Allocated
NRV Weighting X Joint Costs
Cost Accounting
Horngreen, Datar, Foster
Constant Gross Margin
ƒ Allocates joint costs to joint products in a way that
the overall gross-margin percentage is identical for
the individual products
ƒ Joint Costs are calculated as a residual amount
ƒ Implicit assumption:
Joint products are a single product with a single aggregate
gross–margin percentage
ƒ 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
Total
Final Sales Value of Production
Cream: 25 gals@ $50/gal
Skim-milk: 75 gals@ $10/gal
Total
$ 1,250
$ 750
$ 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
Sales Values
$ 1,250
$ 750
Total
$ 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
Cost Accounting
$ 100
$ 400
Horngreen, Datar, Foster
$ 500
Method Selection
ƒ If selling price at splitoff is available, use the Sales Value at
Splitoff Method
ƒ If selling price at splitoff is not available, use the NRV
Method
ƒ If simplicity is the primary consideration, Physical-Measures
Method or the Constant Gross-Margin Method could be
used
ƒ Physical-Measures Method might be used if costs are to be
determined for pricing decision (avoid circulars)
ƒ 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
ƒ In Sell-or-Process Further decisions, joint costs are
irrelevant.
ƒ Joint Costs are sunk
ƒ Joint products have been produced, and a prospective
decision must be made: to sell immediately or process
further and sell later
ƒ Separable Costs need to be evaluated for relevance
individually
ƒ Process-further is worthwhile if additional revenues exceed
additional costs
Cost Accounting
Horngreen, Datar, Foster
Relevant Costs II:
Performance evaluation and pricing
ƒ 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 the
managers perspective
ƒ 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
ƒ Outputs of a joint production process that have low sales
values compare to the sales values of the other outputs
ƒ Two methods for accounting for byproducts:
ƒ Production Method
• recognizes byproduct inventory as it is created, and sales and costs
at the time of sale
ƒ Sales 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
ƒ Assume a firm produces a main product and a byproduct in
a joint production process
ƒ Both products are not processed further after splitoff point
ƒ Production costs for the whole process are $1,000
ƒ Main product sells for $ 50, byproduct for $ 1
Main product
Byproduct
Beginning
Inventory
0
0
Cost Accounting
Production
100
5
Sales
80
4
Horngreen, Datar, Foster
Ending
Inventory
20
1
Profit and Loss Account
Production versus Sales Method
Production Method
Revenues:
Main Product
Byproduct
Total revenues
Costs of goods sold :
Total manufacturing costs
Deduct byproduct revenue
Net manufacturing cost
Deduct main product inventory
Cost of goods sold
Gross margin:
Gross margin percentage
Inventoriable Costs (end of period)
Main product
Byproduct
Cost Accounting
Sales Method
4,000
4,000
4,000
4
4,004
1,000
-5
995
199
796
3,204
0.801
1,000
199
1
Horngreen, Datar, Foster
1,000
200
800
3,204
0.8002
200
Sales Method versus Production Method
ƒ 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
ƒ 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
ƒ All products yielded from joint product processing have
some positive value to the firm.
ƒ Joint processing costs are always relevant for pricing
decisions of the final product.
Cost Accounting
Horngreen, Datar, Foster
Pick your Choice
ƒ 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:
Ems
Ils
Production
20,000 units
25,000 units
Sales Value at Splitoff
$5
$6
ƒ 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
Cost Accounting
Horngreen, Datar, Foster