Process, Joint and BYProduct Costing
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14-1
Process Accounting
Process costing system measures the cost of products under
conditions of continuous production, sequential processing
and homogeneous output. The procedure under such a system
of costing essentially involves averaging the total costs of a
process or a department. It is used in industries such as
chemicals, food processing, breweries, petroleum refining,
paper, glass, metal manufacturing and so on.
Process costing assumed a sequential flow of cost from one
process to another as unit of output pass through a
number of specified production processes.
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14-2
COST ACCUMULATION IN
PROCESS COSTING
The procedure to determine the cost will depend on, firstly,
the stage of completion of the product, in each process,
secondly, the extent of wastage, spoilage of units in
the process and, thirdly, the inter-process profits.
In cases where some units are complete, while others are
incomplete or partially complete, for the purpose of
cost accumulation, the partially completed units
are to be converted into comparable
equivalent units.
Equivalent units = [Actual number of partially completed units ×
Stage of completion]
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14-3
Completed Units
Example 1: A product passes through two processes, A and B.
During the month ended June 30, 1,500 units were produced. The
detailed cost break-up is as follows:
Process A
Process B
Rs 90,000
Rs 75,000
Direct labour
75,000
1,50,000
Direct expenses
15,000
18,000
Direct materials
Indirect overhead costs during the period were Rs 60,000
apportioned to the processes on the basis of direct labour cost. No
work-in-progress existed at the beginning and end of the period.
Prepare relevant process accounts.
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14-4
Solution
Process A Account
To direct materials
To direct labour
To direct expenses
To indirect overheads (Rs 60,000 ×
1/3)
Rs 90,000 By Cost of output
75,000 transferred
to
15,000 process B
20,000
2,00,000
Rs 2,00,000
________
2,00,000
Process B Account
To process A (cost transferred)
To direct material
To direct labour
To direct expenses
To indirect overheads
(Rs 60,000 × 2/3)
Rs 2,00,000
75,000
1,50,000
18,000
By cost of output
transferred to
finished goods
inventory
40,000
4,83,000
Rs 4,83,000
________
4,83,000
Finished Goods Inventory
To process B (cost of output)
4,83,000
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14-5
Example 2
From the following information of ABC Manufacturers Limited, prepare a
statement of equivalent units.
Opening inventory: Partially completed units (40 per cent complete)
Units introduced during the period
Closing inventory (partially completed units: 70 per cent complete)
600
10,000
2,000
Solution
Statement of Equivalent Units
1. Work necessary to complete opening inventory (600 × 0.60)
2. Work necessary to start and finish units introduced during
the current year
(10,000 – 2,000 partially completed units)
3. Work performed on closing inventory (2,000 × 0.70)
Total number of equivalent units
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360
8,000
1,400
9,760
14-6
Example 3
From the following production record of XYZ Manufacturing Company Ltd,
prepare a statement of equivalent units:
Units in process-opening
Stage of completion (%):
2,000
material
100
labour
60
overheads
50
New units introduced
20,000
Units completed
18,000
Units in process-closing
Stage of completion (%):
4,000
material
100
labour
50
overheads
40
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14-7
Solution
Table 1 Statement of Equivalent Units
Input
Opening
inventory
2,000 units
+
20,000
units
introduced
during the
current
period
_____
22,000
Particulars
Work expended on
opening inventories
(100 per cent stage of
completion)
Units
started
and
completed
during the current
period
(18,000 total units
completed inventory)
Closing inventory
(work-in-process)
Number
of
units
(comple
ted
or
otherwi
se)
Work performed
during the current
period [stage of
completion (per
cent)]
Equivalent produced
units: input units× stage
completion in respect of
Mate
rial
Lab
our
Overheads
Materia
l
Labour
2,000
Nil
40
50
—
800
1,000
16,000
100
100
100
16,000
16,000
16,000
4,000
22,000
100
50
40
4,000
20,000
2,000
18,800
1,600
18,600
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Overheads
14-8
Process Accounts/Production
Cost Report
The cost of production is shown in the form of a production
cost report and/or process cost account.
The total cost of production of each process is split into the
cost of output and the closing inventory /work-in-process.
The distribution between these two elements depends on the
method of valuation of work-in-process, namely, (i)weighted
average method and (ii) first-in-first-out (FIFO) method.
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14-9
Weighted Average Cost Method
Under this method, total costs in process are divided by
equivalent units produced by the process to ascertain
the cost per equivalent unit.
Exhibit 1: Process Account (Weighted Average Cost Method).
ToWork-in-process (opening
inventory)
To Current costs
Material
Labour
Overheads
To Closing work-in-process
inventory to be carried to the
next period
By Cost of completed units
transferred
to
next
process/finished
goods
inventory A/c
By Closing work-in-process
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14-10
FIFO Method
Unlike the weighted average cost method, this method is based on the assumption
that units in process at the beginning of the period are the first to be completed
and accordingly the first costs incurred in the current period should be
attached to the units of the opening work-in-process inventory.
Exhibit 2: Process Account (FIFO Method)
To Work-in-process opening inventory during
the current period (units partially
completed in earlier period)
To Current costs
1. To complete opening inventory units
2. To work initiated on new units in
the current period in this process:
(a)Some of which are completed
and transferred
(b)Some of which are not yet completed
and carried as opening inventory
for next period
To Closing work-in-process inventory
to be carried forward to the next period
By units completed
1.
Units started in earlier period
and completed during the
current period
2.
Units started and completed
during the current period
3.
Units
started
but
not
completed during the current
period
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14-11
Example 4
For the firm in Example 3, assume the following:
Cost of 2,000 units in process (opening):
Materials
Labour
Overheads
Processing costs during the current period
Materials
Labour
Overheads
Rs 6,000
3,600
2,400
69,900
56,560
58,360
Prepare a cost of production report for the current period using (a)
weighted average, and (b) FIFO costing methods.
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14-12
Solution
Cost of Production Report of Process A (Weighted average cost method)
Flow of completed or partially completed units:
Opening
2,000
Introduced
20,000
Total in process
22,000
Less completed
18,000
In process
4,000
Equivalent units in process:
Conversion costs
Material Labour Overhead
Units completed
Equivalent
inventory
units
in
18,000
18,000
18,000
4,000
2,000
1,600
22,000
20,000
19,600
ending
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14-13
(Contd.)
Total cost to be accounted for:
Material
Labour
Overhead
s
Total
Rs 6,000
Rs 3,600
Rs 2,400
Rs 12,000
Current costs
69,900
56,560
58,360
1,84,820
Total cost in process
75,900
60,160
60,760
1,96,820
Equivalent units (EU) in process
22,000
20,000
19,600
—
3.45
3.008
3.1
9.558
Work-in-process (opening)
Cost per equivalent unit in process
(Total cost ÷ EU)
Costs accounted for:
Transferred to finished goods
inventory (18,000× Rs 9.558)
1,72,044
Work-in-process (closing inventory)
Materials (4,000× 100 per cent× Rs
3.45)
Rs 13,800
Labour (4,000× 0.50× Rs 3.008)
6,016
Overheads (4,000× 0.40× Rs 3.1)
4,960
Total costs accounted for
24,776
1,96,820
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14-14
Cost of Production Report of Process A (FIFO method)
Flow of completed or partially completed units:
Opening
2,000
Introduced
20,000
Total in process
22,000
Less completed
18,000
In process
4,000
Equivalent units manufactured:
Conversion costs
Material
Units completed
Labour
Overheads
18,000
18,000
18,000
4,000
2,000
1,600
22,000
20,000
19,600
in
2,000
1,200
1,000
Equivalent units manufactured
20,000
18,800
18,600
Equivalent
inventory
units
in
ending
Equivalent units in process
Less equivalent
opening inventory
units
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14-15
(Contd.)
Total costs to account for:
Material
Opening
process
—
Overhead Total
s
—
Rs 12,000
Rs 69,900 Rs 56,560 Rs 58,360
1,84,820
work-in-
Current costs
Labour
—
Total costs in process
1,96,820
Equivalent
units
manufactured
20,000
18,800
18,600
—
Cost
per
equivalent
unit
manufactured
3.495
3.0085
3.1376
9.6411
Costs accounted for:
Transferred to finished goods
inventory
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14-16
First batch:
Work-in-process
inventory
opening
Rs 12,000
Add conversion costs:
Labour
3.0085)
(2,000×
0.40×
Rs
2,406.8
Overheads (2,000× 0.50× Rs
3.1376)
3,137.6
Rs 17,544.4
Second batch:
Started and completed (16,000× Rs 9.6411)
1,54,257.6
Work-in-process (closing):
Materials (4,000× 100 per cent× Rs 3.495)
Labour
3.0085)
(4,000×
0.50×
13,980
Rs
6,017
Overheads (4,000× 0.40× Rs
3.1376)
5,020.16
25,017.16
1,96,819.16
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14-17
Comparison For comparison of the two costing methods, summary results
of important items are listed below:
FIFO
Weighted
average
cost
(A) Cost of output transferred
from
(i) Opening inventory
(ii) Current production
Rs 17,544.40
1,54,257.60
(B) Closing work-in-process
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Rs 1,72,044
Rs 1,71,802
25,017.16
24,776
1,96,819.16
1,96,820
14-18
Spoilage
The spoilage of units under process costing may take place due to a
variety of reasons, like use of sub-standard material, poor workmanship,
evaporation, shrinkage, break-down of machines, and so on. The effect of
spoilage is that the number of actual units produced is less than the units
introduced initially. The spoilage or wastage may be normal or abnormal.
The unit cost with normal spoilage.
=
Total process costs – Salvage value of normal spoilage
Total units introduced – Normal loss in units
Abnormal Loss
Abnormal loss = [(Abnormal loss in units × Unit production cost) –
Salvage value of abnormal spoilage]
Inter-Process Profits
Inter-process profit is the profit arising out of transfer of the product of
one process to the other on the basis of market/inflated price.
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14-19
Example 5
Six hundred kgs of material was charged to process I at the rate of Rs 4 per
kg. The direct labour accounted for Rs 200 and the other departmental
expenses amounted to Rs 760. The normal loss is 10 per cent of input. During
the period, the actual production was 500 kgs and 100 kgs was scrap.
Assuming that the scrap is saleable at Rs 2 per kg, prepare a ledger account
of process I, showing the values of normal and abnormal losses.
Solution
Process I Account
Particulars
To materials
Units
(kgs)
Amount
Particulars
600 Rs 2,400 By normal
0.10)
To wages
Units Amount
(kgs)
loss
(600×
200 By abnormal loss
To
departmental
expenses
By process II (500 units
transferred at Rs 6 each)
60
Rs 120
40
240
500
3,000
600
3,360
760
600
3,360
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14-20
Working Notes
Cost per unit = (Rs 3,360 - Rs 120)/ 540 units = Rs 6
Amount of abnormal loss
Units introduced
600
Less normal loss (10 per cent)
60
Normal output expected
540
Less actual output achieved
500
Abnormal loss (units)
40
(×) Cost per unit
Rs 6
Total loss
240
Less sale value of scrap (40× Rs 2)
Total
80
160
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14-21
Inter-Process Profit
Example 6 (Inter-Process Profits)
A product passes through three processes, A, B, and C. The output of
process A and B is charged to the next process at a price calculated to
give a profit of 16.67 per cent on transfer price while the output of process
C is charged to the finished stock account at a profit of 13.33 per cent on
the transfer price. From the following particulars, prepare the process cost
accounts and calculate the amount of reserve that should be made in
respect of the stock in hand.
Materials and labour
Closing stock
Process A
Process B
Process C
Rs 7,000
Rs 2,800
Rs 4,800
2,000
2,800
2,000
There was no stock in hand at the beginning of the period. The closing
stocks are valued at prime cost in each process.
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14-22
Solution
Process A Account
Particulars
Amount Particulars
Amount
To materials and labour
Rs 7,000 By closing stock
Rs 2,000
To profit (Rs 6,000 ×
0.1667)
By process B (Rs 5,000 ×
1,000 120/100)
6,000
8,000
8,000
Process B Account
Particulars
Amount Particulars
To process A
Rs 6,000 By closing stock
To material and labour
To profit (Rs 7,200 ×
0.1667)
2,800 By process C
6,000 × 120/100)
Amount
Rs 2,800
(Rs
7,200
1,200
________
10,000
10,000
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14-23
Process C Account
Particulars
To process B
To materials and labour
To profit (Rs 11,538 ×
0.1333)
Amount
Particulars
Rs 7,200 By closing stock
4,800 By finished goods
(10,000 × 115.38/100)
Amount
Rs 2,000
11,538
1,538
______
13,538
13,538
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14-24
Working Notes
1 Profit of 16.67 per cent on transfer means 20 per cent on cost
price.
2 Likewise, profit of 13.33 per cent on transfer price means 15.38
per cent on cost.
3 Provision for unrealised profit:
Process A: Nil
Process B: (Rs 1,000 × 2,800)/8,800 = Rs 318
Process C: Closing stock of process C of Rs 2,000 is made up of
respective cost proportions of C: B, that is, 2:3 (Rs 4,800: Rs
7,200).
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14-25
Process C’s share is = Rs 2,000 × 2/5 = Rs 800
Process B’s share is = Rs 2,000 × 3/5 = Rs 1,200
Profit included in Rs 1,200 (process B’s cost) is = Rs 1200 × 20/120 = Rs 200
(i)
Profit included in Rs 1,000. This includes part of process A’s costs: Rs
1,000 × 60/88= Rs 682.
Rs 682 includes profit element of = Rs 682 × 20/120 = Rs 113
(ii)
Total profit included in process C = Rs 313 (200 + 113)
(i + ii)
Statement of Profit
Process A
Rs 1,000
Process B
Rs 1,200
Less provision for unrealised profit
Process C
318
882
1,538
Less provision for unrealised profit
Profit realised
313
1,225
3,107
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14-26
Alternatively
Process A Account
Particulars
To materials
and labour
To profit (Rs
5,000 × (50/3) ×
(3/250)
Total
(Rs)
7,000
Cost
(Rs)
7,000
Profi Particulars
t (Rs)
— By closing
stock
By process
B (transferred)
1,000
—
1,000
8,000
7,000
1,000
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Total
(Rs)
Cost
(Rs)
Profit
(Rs)
2,000
2,000
—
6,000
5,000
1,000
8,000
7,000
1,000
14-27
Process B Account
Total
(Rs)
To process A
To materials
labour
and
Cost
(Rs)
Profit
(Rs)
Total
(Rs)
Cost
(Rs)
Profit
(Rs)
6,000 5,000
1,000 By Closing
stock (2,800
× 1,000)
÷8,800
2,800
2,482
318
2,800 2,800
— By process
C
7,200
5,318
1,882
10,000
7,800
2,200
(transferred)
To profit and loss
A/c (Rs 6,000 × (50 ×
3) ÷ (3 × 250))
—
1,200
10,000 7,800
2,200
1,200
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14-28
Process C Account
To process
B
Rs 7,200
Rs 5,318
To
materials
and labour
4,800
4,800
1,538
—
1,538
13,538
10,118
3,420
To
profit
and
loss
A/c (0.1333
×
Rs
11,538)
Rs 1,882 By
closing Rs 2,000
stock
— By finished
goods A/c (at
115.38
per
cent of cost)
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Rs 1,687
Rs 313
11,538
8,431
3,107
13,538
10,118
3,420
14-29
Joint Products
Two or more products produced simultaneously from a common set
of inputs through a single manufacturing (joint) process are called
joint products. The joint products can be sold either at the stage of
production (split-off point) itself or they can be processed further.
The
costs
incurred
before
the
split-off
point
are
called
joint/common/inseparable costs and the costs incurred beyond that point
are known as separable costs. The crucial factor in accounting for joint
products is the allocation of joint costs among the joint/multiple products
from the joint process.
Split-off Point
Split-off point is that stage in the manufacturing process where
joint products are separately identifiable.
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14-30
Allocation of Joint Costs
The commonly used methods of allocating joint
process costs are:
(1) Physical Quantities Method/Unit Method
(2) Relative Sales Value/Net Realisable Value (NRV)
Method
(3) Net Realisable Value Less Normal Profit Method
(4) Weighted Average Method
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14-31
Physical Quantities Method/Unit Method
Under the physical quantities method, the total joint costs are allocated to
the joint products in proportion to the physical measurement of output.
Example 7. (Allocation of Joint Costs Under Unit Method)
Royal Industries Ltd manufactures products X, Y and Z by processing a
specific raw material in Department 1. The production process is such that
every 1,100 kgs of raw materials that is put into Department 1 yields 400 kgs
of X, 250 kgs of Y and 350 kgs of Z. The total cost of processing a batch of
1,100 kgs of raw materials through Department 1 is Rs 22,000. Allocate the
joint costs to the three products using the physical quantity method.
Solution
Joint Cost Allocation Using Unit Method
Product
X
Y
Z
Output (kgs)
400
250
350
1,000
Rates (per cent)
40
25
35
100
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Allocated joint
cost
Rs 8,800
5,500
7,700
22,000
Cost per
unit
Rs 22
22
22
22
14-32
This method results in identical unit costs for each product. Identical
benefits exist only if the products are homogeneous. It will, therefore,
provide a satisfactory basis of allocating joint cost if the different products
are homogeneous and their sale prices are relatively close to each other.
Otherwise, it may lead to misleading results in that there will be wide
divergence in the gross margin of the different products as shown in Table
2.
Table 2 Gross Margin of Different Products
Product X
Sales price
Product Y
Product Z
Rs 33
Rs 44
Rs 66
Less cost of production
22
22
22
Cross margin
11
22
44
33.33
50
66.67
Gross margin percentage
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14-33
Relative Sales Value/Net Realisable Value (NRV) Method
In the net realisable value method, joint costs are pro-rated on the basis
of the market value of the joint products.
From the facts in Example 7 and Table 2 and assuming all products are
sold at the split-off point, joint cost allocation under the relative sale value
method would be, as shown in Table 3.
Table 3 Joint Cost Allocation Using Sales Value Method
Product
Output
(kgs)
Market
price
Market
value
Rates
Allocated
joint cost
Cost per
unit
X
400
Rs 33
Rs 13,200
132/473
Y
250
44
11,000
110/473
5,116
20.46
Z
350
66
23,100
231/473
10,744
30.70
22,000
22.00
1,000
47,300
Rs 6,140 Rs 15.35
Thus, the costs per unit are in proportion to the sale prices. The relative sale price
method generates the same margin percentage (53.48 per cent) for all products.
Thus, this approach implies a matching of input costs with revenues generated by
each output.
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14-34
Assuming that for the firm in Example 7, the additional processing for
products X, Y and Z is done in departments 2, 3 and 4 respectively.
Following are the costs incurred in these departments to process the batch
of 1,100 kgs of materials:
Product
Output (kgs)
Department
Further processing/ Unit
separable cost
cost
X
400
2
Rs 6,000
Rs 15
Y
250
3
4,500
18
Z
350
4
7,000
20
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14-35
Assuming no change in market price, joint costs of Royal Industries Ltd would be
allocated as shown in Table 4.
Table 4 Allocation of Joint Costs [Net Realisable Value (NRV) Method]
Product
Output
(kgs)
Market
price
Market
value
Separab
le
cost
Net
realisable
value
Rat
es
Allocated
joint
costs
Joint cost
per unit
X
400
Rs 33
Rs 13,200
Rs 6,000
Rs 7,200
72/2
98
Rs 5,315
Rs 13.28
Y
250
44
11,000
4,500
6,500
65/2
98
4,799
19.19
Z
350
66
23,100
7,000
16,100
161/
298
11,886
33.96
47,300
17,500
29,800
22,000
22.00
1,000
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14-36
The gross margin rates for each product according to this method are
shown in Table 5.
Table 5 Gross Margin Rates
Product X
Sales price
Product Y Product Z
Rs 33.00
Rs 44.00
Rs 66.00
Joint cost
13.28
19.19
33.96
Separable cost
15.00
18.00
20.00
28.28
37.19
53.96
Gross margin
4.72
6.81
12.04
Gross margin rate (percentage)
14.3
15.5
18.21
Less cost of production:
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14-37
Net Realisable Value Less Normal Profit Method
The net realisable value less normal profit method differs from the net
realisable value method to the extent the joint costs less normal profits are
pro-rated.
Table 6 Joint Cost Allocation Using NRV Less Normal Profit Method
Product
Output
(kgs)
Market
value
Normal
profit
Separabl
e
costs
Joint
Joint cost
cost
per unit
allocatio
n
X
400
Rs 13,200
Rs 2,177
Rs 6,000 Rs 5,023
Rs 12.557
Y
250
11,000
1,814
4,500
4,686
22.744
Z
350
23,100
3,809
7,000
12,291
35.117
1,000
47,300
7,800
17,500
22,000
Working Notes
Normal profit ratio = 100 per cent – [Total costs – (Joint + Separable)× 100]
÷ Total market value = 100 per cent – [(Rs 22,000 + Rs 17,500)× 100 ÷ Rs
47,300, 83.5 per cent = 16.5 per cent]
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14-38
Weighted Average Method
Where the joint products are heterogeneous, the weighted average cost
method provides a reasonable basis for allocating the joint costs.
Continuing with the example of Royal Industries Ltd, assume that the
following are the weights assigned to products X, Y and Z after taking into
consideration a variety of factors: X, 1; Y, 2; Z, 4. Using the weighted
average method, the joint costs are allocated in Table 7.
Table 7 Joint Cost Allocation Using Weighted Average Method
Product
Output
(kgs)
Weight
Weighte
d output
Ratio
Allocated
joint cost
Cost per
unit
X
400
1
400
4/23
Rs 3,826
Rs 9.56
Y
250
2
500
5/23
4,783
19.13
Z
350
4
1,400
14/23
13,391
38.26
1,000
2,300
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22,000
14-39
By-Products
A by-product is incidental to the process of manufacturing the
main/joint product. The accounting treatment depends on whether
the by-product is sold at the split-off point or is processed further.
The two most commonly-used methods of accounting for byproducts are:
(1) Miscellaneous income method
(ii) Net realisable value method, (NRV)
Recognisation of No Profit on the Sale of By-products
Recognisation of Some Normal Profit on the Sale of By-products
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(i) Miscellaneous Income Method
Under the miscellaneous income method, the income
generated by the by-products is treated as a miscellaneous
income and all the associated costs are charged to the main
product.
(ii) Net Realisable Value Method, (NRV).
According to the NRV method, the by-product is valued at its
net realisable value and the joint costs are pro-rated between
the main product and the by-product. Joint process cost
allocated to by-product = (Sale price of by-products – Selling
and distribution costs of by-products).
A variation of this is to recognise some normal profit from the
sale of by-products.
Joint cost allocated to by-products = (Sale price of byproducts – Normal profit – Selling and distribution costs of byproduct).
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Example 8
For the facts contained in Example 7, let as assume further that joint
production process also yields by-product (70 kgs) in addition to three main
products X, Y, Z. Its selling price is Rs 2 per kg and selling costs are Rs 0.50
per kg. Determine the share of joint costs (i) if firm does not recognize profit
on the sale of its by-product; and (ii) if it recognizes 10 per cent profit on
such sales.
Solution
Share of Joint Costs
(i) When no profits are recognized:
Sales revenue (70 kgs × Rs 2)
Less selling costs (70 kgs × Rs. 0.50)
Share of joint costs (70 kgs × Rs 1.50)
(ii) When 10 per cent profits are recognised:
Sales revenue (70 kgs × Rs 2)
Less normal profit (Rs 140 × 0.10)
Less selling costs (70 kgs × Rs 0.50)
Share of joint costs (70 kgs × Rs 1.30)
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Rs 140
35
105
140
14
35
91
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SELL NOW (AT SPLIT-OFF
POINT) OR PROCESS
FURTHER
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Example 9 (Sell Now or Process Further: Single Product)
A B C Ltd manufactures a single product which it sells to firms which
process it further before sale. The normal quarterly operating volume for
the company is 50,000 units produced and sold. The relevant cost data are
as follows:
Selling price
Rs 10.00
Less standard costs:
Direct materials
Rs 3.00
Direct labour
1.50
Variable manufacturing overheads
1.00
Fixed manufacturing overheads (Rs 25,000 per
quarter)
0.50
Variable selling overheads
1.00
Fixed selling expenses (Rs 12,500 per quarter)
0.25
Standard profit per unit
7.25
2.75
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The company’s management is considering the possibility of further
processing the product and selling it directly to the customers. The
management estimates that the product can be sold @ Rs 14 per unit
after further processing. The following are the estimates of the
additional (per unit/ quarter) costs of processing 50,000 units:
Direct labour
Rs 1.00
Variable manufacturing overheads
0.50
Variable selling costs
0.20
Additional fixed manufacturing overheads (per quarter)
Additional sales expenses (per quarter)
10,000
5,000
You are required to compute the cost (i) without, and (ii) with further
processing. Is further processing advisable?
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Solution
Cost Comparison: Incremental Analysis
Particulars
Without further
processing
With further processing
Difference from further
processing
Total
Per unit
Total
Per unit
Rs 10.00
Rs 5,00,000
Rs 14.00
Rs 7,00,000
Rs 4.00
Rs 2,00,000
3.00
1.50
1,50,000
75,000
3.00
2.50
1,50,000
1,25,000
0.00
1.00
50,000
1.00
1.00
6.50
3.50
50,000
50,000
3,25,000
1,75,000
1.50
1.20
8.20
5.80
75,000
60,000
4,10,000
2,90,000
0.50
0.20
1.70
2.30
25,000
10,000
85,000
1,15,000
Per unit
Sales
Less variables costs:
Direct material
Direct labour
Manufacturing
overheads
Selling overheads
Total
Contribution
Less separable
identifiable fixed
costs:
Manufacturing
Sales
Product margin
Less common fixed
costs:
Manufacturing
Sales
Net income
—
—
1,75,000
10,000
5,000
2,75,000
25,000
12,500
1,37,500
25,000
12,500
2,37,500
Total
10,000
5,000
1,00,000
—
—
1,00,000
Since further processing would result in a greater product margin and net income, the new
proposal is acceptable.
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Example 10 (Sell or Process Further: Multiple Products)
XYZ Ltd produces three products, A, B and C. One type of a raw material is
used for all these products. Raw material enters the process in department
1 of the factory. Department 1 separates material for products A, B and C.
During the last quarter, Rs 4,00,000 of material was issued to Department 1.
Other direct costs of operating Department 1 were Rs 2,00,000. The output
of products A, B and C from Department 1 was: A, 10,000 units; B, 5,000
units; C, 2,000 units.
Products A, B and C can be sold after being processed from Department 1
(split-off point) at prices of Rs 60, Rs 30 and Rs 20 respectively. After the
split off, product A could be processed further in Department 2. With
additional processing, product A can be sold at Rs 70 per unit. After the
split-off, product B could be processed further in Department 3 for Rs
30,000 additional cost, and will fetch Rs 35 per unit after processing.
Product C is not suitable for further processing and has to be sold at the
point of split-off. What action should be management take?
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Solution
Sell or Process Further: Decision Analysis
Particulars
Sales
Less separable
costs Joint cost
of Rs 6,00,000
from
Department 1
Contribution
(decrease)
Product A
Product B
Sell now
Process
further
Difference
from further
processing
Sell now
Process
further
Differenc
es
from
further
Processi
ng
Rs 6,00,000
—
Rs 7,00,000
50,000
Rs 1,00,000
50,000
Rs 1,50,000
—
Rs 1,75,000
30,000
Rs 25,000
30,000
1,45,000
(5,000)
Irrelevant as costs not affected by the decision
Rs 6,00,000
6,50,000
50,000
1,50,000
Thus, it is profitable to process product A further because it yields an incremental profit of Rs 50,000,
(additional revenue being Rs 1,00,000 and additional cost, Rs 50,000). The decision is based on the
assumption that there is no other opportunity cost for using the facilities of Departments 2 and 3.
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By-Product Processed Further
There are several methods of accounting for costs of further processing:
(1) Recognition of No Profit on Sale of By-products Method
Under this method, share of joint costs allocated to by-products would be
determined by subtracting both selling and further processing
costs from the sale price of by-products.
Sale price of by-products – Further processing cost beyond split-off point –
Selling cost = Joint costs.
(2)
Recognition of
Cost Method
Normal
Profit
on
Sale
of
By-Products/Reversal
Under this method, by-products are valued at the price which would
have been paid by the firm in making outside purchases for
these products.
(3) Separate Cost Record for By-products
This method is most appropriate in situations when the joint manufacturing
process yields by-products which are relatively of high value and/or of
large quantity; they also require further processing after separation
from the joint manufacturing process.
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Example 11 (Reversal Cost Method)
In manufacturing the main product, Hypothetical Ltd processes the
incidental waste into two products, A and B. From the following data relating
to the products, you are required to prepare a comparative profit and loss
statement showing the individual costs and other details. The total costs
upto separation point were Rs 3,10,400.
Main product
Sales
Costs after separation
Rs 8,00,000
Rs 64,000
Rs 96,000
80,000
12,800
14,400
20
30
10
15
Estimated net profit (per
cent to sales value)
Estimated selling expenses
(as per cent to sales value)
By-product A By-product B
20
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Solution
Statement Showing Allocation of Joint Costs
Particulars
By-product A
Sales
By-product B
Rs 64,000
Rs 96,000
12,800
28,800
6,400
14,400
separable costs
12,800
14,400
Share of joint costs allocated
32,000
38,400
Less: estimated net profit on sale
(20 per cent, A; and 30 per cent, B)
estimated selling expenses
(10 per cent, A, and 15 per cent, B)
Share of main products in joint costs, therefore, would be: Rs 3,10,400 – (Rs
32,000 + Rs 38,400) =Rs 2,40,000.
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Comparative Profit and Loss Account
Particulars
Sales revenue
Main product
By-product A
By-product B
Rs 8,00,000
Rs 64,000
Rs 96,000
2,40,000
32,000
38,400
80,000
12,800
14,400
Gross profit
4,80,000
19,200
43,200
Less selling expenses
1,60,000
6,400
14,400
Net profit
3,20,000
12,800
28,800
Less cost of production:
Joints costs
Separable costs
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