Joint Costs

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Thème 5
Cost Allocation:
Joint Products and Byproducts
Contrôle Interne Avancé-HEC Lausanne2007/2008
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Joint Cost Terminology
 Joint Costs – costs of a single production
process that yields multiple products
simultaneously,
 Split-off 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.
Contrôle Interne Avancé-HEC Lausanne2007/2008
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Joint Cost Terminology
 Categories of Joint Process Outputs:
1. Outputs with a positive sales value,
2. Outputs with a zero sales value.
E.g., offshore processing of hydrocarbons yields oil and natural gas, which
have positive sales value, and it also yields water, which has zero sales
value and is recycled back into the ocean.
 Product – any output with a positive sales value,
or an output that enables a firm to avoid incurring
costs (e.g., an intermediate chemical product used
as input in another process):
 Value can be high (main or joint products) or low
(byproduct).
Contrôle Interne Avancé-HEC Lausanne2007/2008
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Joint Cost Terminology
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,
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.
Contrôle Interne Avancé-HEC Lausanne2007/2008
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Joint Cost Terminology
Byproducts – outputs of a joint production
process that have low sales values
compare to the sales values of the other
outputs.
Contrôle Interne Avancé-HEC Lausanne2007/2008
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Sum-Up
 Joint costs are costs which yield multiple products
simultaneously,
 Split-off point is the juncture in the process when
separate identifiable products emerge,
 Separable costs are costs incurred beyond the split-off
point and are assignable to separate products.
Split-off
Point
Product A
Separable
Costs A
Product A
Product B
Separable
Costs B
Product B
Joint
Costs
Contrôle Interne Avancé-HEC Lausanne2007/2008
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Sum-up
 Joint products have a relatively high sales value and are
not separately identifiable as individual products until the
split-off point,
 Main product is the one with the highest sales value
resulting from a process yielding two or more products,
 Byproducts have a low sales value relative to sales value
of the main or joint products,
 Scrap products have a minimal (often zero) sales value.
Main Products
Joint Products
High
Byproducts
Sales Value
Contrôle Interne Avancé-HEC Lausanne2007/2008
Low
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Joint Process Flowchart
Steam:
An Output with Zero Sales Value
Joint Product #1
Single Production
Process
Joint Product #2
Byproduct
Contrôle Interne Avancé-HEC Lausanne2007/2008
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Reasons for Allocating Joint Costs
Required for GAAP and taxation purposes,
Cost values may be used for evaluation
purposes,
Cost-based contracting.
Contrôle Interne Avancé-HEC Lausanne2007/2008
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Joint Cost Allocation Methods
 Physical Measures – allocate using
tangible attributes of the products, such
as pounds, gallons, barrels, etc.
 Market-Based – allocate using marketderived data (dollars):
1. Sales value at split-off,
2. Net Realizable Value (NRV),
3. Constant Gross-Margin percentage NRV.
Contrôle Interne Avancé-HEC Lausanne2007/2008
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Physical-Measure Method
Allocates joint costs to joint products on
the basis of the relative weight, volume, or
other physical measure at the split-off
point of total production of the products.
Contrôle Interne Avancé-HEC Lausanne2007/2008
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Physical Measure Method
 Allocate joint
costs to products
based on their
relative
proportions at
the split-off point.
Split-off
Point
Cream 25 units
Raw
Milk
$400
Skim 75 units
Cream
Physical measure
Weighting
Joint costs allocated
25
25%
$100
Contrôle Interne Avancé-HEC Lausanne2007/2008
Skim
Total
75
75%
$300
100
100%
$400
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Sales Value at Split-off Method
Uses the sales value of the entire
production of the accounting period to
calculate allocation percentage and not
just the quantity sold because joint costs
were incurred on all units produced, not
just the portion sold during the current
period.
Contrôle Interne Avancé-HEC Lausanne2007/2008
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Sales Value at Split-off Method
 Allocate joint
costs to products
based on their
relative value at
the split-off point.
Split-off
Point
Raw
Milk
$400
Skim $300
Cream
Sales value at split-off
Weighting
Joint costs allocated
Cream $200
$200
40%
$160
Contrôle Interne Avancé-HEC Lausanne2007/2008
Skim
Total
$300
60%
$240
$500
100%
$400
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Net Realizable Value Method
Allocates joint costs to joint products on
the basis of relative NRV of total
production of the joint products,
NRV = Final Sales Value – Separable
Costs.
Contrôle Interne Avancé-HEC Lausanne2007/2008
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Net Realizable Value (NRV) Method
 Allocate joint costs to products based on their estimated
final selling prices less separable processing costs.
Raw
Milk
$400
Cream
Processing
$280
Butter $500
Skim
Processing
$520
Condensed
Milk $1,100
Split-off
Point
Final sales value
Separable processing costs
Net realizable value
Weighting
Joint cost allocation
Cream
Skim
Total
$500
280
220
27.5%
$110
$1,100
520
580
72.5%
$290
$1,600
800
800
100%
$400
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Pages 573 - 574
Constant Gross Margin NRV Method
Allocates joint costs to joint products in a
way that the overall gross-margin
percentage is identical for the individual
products,
Joint Costs are calculated as a residual
amount.
Contrôle Interne Avancé-HEC Lausanne2007/2008
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Constant Gross Margin % NRV
Method
 Allocate joint costs so that the gross margin % for each
product is the same.
Butter
Cream
Condensed
Milk
Total final sales value
Joint and separable costs
Gross margin
Gross margin %
Total
$1,600
1,200
$400
25%
Final sales value
Gross margin @ 25%
Imputed total costs
Separable costs
$500
125
375
280
$1,100
275
825
520
$1,600
400
1,200
800
Allocated joint costs
$ 95
$ 305
$400
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Pages 574 - 575
Irrelevance of Joint Costs
 When considering whether to sell a product at the splitoff point or process further, ignore joint costs.
Split-off
Point
Raw
Milk
$400
Cream
Processing
$280
Butter $500
Skim
Processing
$520
Condensed
Milk $1,100
Cream versus Butter Cream
Sell @ Split-off
Relevant revenue
Relevant costs
Incremental operating income
$200
$200
Contrôle Interne Avancé-HEC Lausanne2007/2008
Process Further
$500
280
$320
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Method Selection
 If selling price at split-off is available, use the
Sales Value at Splitoff Method,
 If selling price at splitoff is not available, use the
NRV Method,
 If simplicity is the primary consideration,
Physical-Measures Method or the Constant
Gross-Margin Method could be used,
 Despite this, some firms choose not to allocate
joint costs at all.
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Sell-or-Process Further Decisions
In Sell-or-Process Further decisions, joint
costs are irrelevant. Joint products have
been produced, and a prospective
decision must be made: to sell
immediately or process further and sell
later,
Joint Costs are sunk,
Separable Costs need to be evaluated for
relevance individually.
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Sell-or-Process Further Flowchart
Final
Product
#1
Joint Product #1
Further Processing Dept 1
Single Production
Process
Final
Product
#2
Joint Product #2
Further Processing Dept 2
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Byproducts
Two methods for accounting for
byproducts:
Production Method – recognizes
byproduct inventory as it is created, and
sales and costs at the time of sale,
Sales Method – recognizes no byproduct
inventory, and recognizes only sales at the
time of sales: byproduct costs are not
tracked separately.
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