Cost Allocation: Joint Products and Byproducts

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Cost Allocation Joint Products and
Byproducts

• Chapter 16

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Joint Costing Overview

• Terminology
• Joint cost examples
• Joint versus Byproducts
• Ways to allocate
• Sales-value at Splitoff
• NRV
• Constant Gross Margin
• Physical Measure
• Accounting for Byproducts

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Joint-Cost Basics
Joint products
Joint costs
Splitoff point
Byproduct
Separable costs
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Joint-Cost Basics
Coal
Gas
Benzyl
Tar
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Joint-Cost Basics
Timber (logs)
2x4s
1x8 clear
Bark
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Joint Products and Byproducts
Main Products Joint Products
Byproducts
High
Low
Sales Value
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Why Allocate Joint Costs?

• to compute inventory cost and cost of goods sold

• to determine cost reimbursement under contracts

• for insurance settlement computations

• for rate regulation

• for litigation purposes

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Approaches to AllocatingJoint Costs
Two basic ways to allocate joint costs to
products are
Approach 2 Physical measure
Approach 1 Market based
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Approach 1 Market-based Data (3 ways)
Sales value at splitoff method
Estimated net realizable value (NRV) method
Constant gross-margin percentage NRV method
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Allocating Joint Costs Example
10,000 units of A at a selling price of 10
100,000
Joint processing cost is 200,000
10,500 units of B at a selling price of 30
315,000
11,500 units of C at a selling price of 20
230,00
Splitoff point
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Allocating Joint Costs Example(Sales-Value-at-Spl
itoff method)
A
B C Total Sales
Value 100,000 315,000 230,000 645,000 Allocat
ion of Joint Cost 100 645 31,008 315
645 97,674 230 645 71,318
200,000 Gross margin 68,992 217,326 158,682
445,000
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Estimated Net Realizable Value (NRV) Method
Example
Assume that the Company can process products A,
B, and, C further into A1, B1, and C1.
The new sales values after further processing are
A1 10,000 12.00 120,000
B1 10,500 33.00 346,500
C1 11,500 21.00 241,500
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Estimated Net Realizable Value (NRV) Method
Example
Additional processing (separable) costs are as
follows
A1 35,000
B1 46,500
C1 51,500
What is the estimated net realizable value of
each product at the splitoff point?
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Estimated Net Realizable Value (NRV) Method
Example
Product A1 120,000 35,000 85,000
Product B1 346,500 46,500 300,000
Product C1 241,500 51,500 190,000
How much of the joint cost is allocated to each
product?
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Estimated Net Realizable Value (NRV) Method
Example
Joint cost allocated To A1 85 575 200,000
29,565
To B1 300 575 200,000 104,348
To C1 190 575 200,000 66,087
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Estimated Net Realizable Value (NRV) Method
Example
Allocated Separable Inventory joint
costs costs costs A1 29,565
35,000 64,565 B1 104,348 46,500
150,848 C1 66,087 51,500
117,587 Total 200,000 133,000 333,000
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Constant Gross-MarginPercentage NRV Method
This method entails three steps
Step 1 Compute the overall gross-margin
percentage.
Step 2 Use the overall gross-margin
percentage and deduct the gross margin from
the final sales values to obtain the total costs
that each product should bear.
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Constant Gross-MarginPercentage NRV Method
Step 3 Deduct the expected separable costs from
the total costs to obtain the joint-cost
allocation.
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Constant Gross-MarginPercentage NRV Method
What is the expected final sales value of
total production during the accounting period?
Product A1 120,000 Product B1
346,500 Product C1 241,500 Total 708,000
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Constant Gross-MarginPercentage NRV Method
Step 1 Compute the overall gross-margin
percentage.
Expected final sales value 708,000 Deduct
joint and separable costs 333,000 Gross
margin 375,000
Gross margin percentage 375,000 708,000
52.966
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Constant Gross-MarginPercentage NRV Method
Step 2 Deduct the gross margin.
Sales Gross Cost
of Value Margin Goods
sold Product A1 120,000 63,559
56,441 Product B1 346,500 183,527
162,973 Product C1 241,500 127,913
113,587 Total 708,000 375,000 333,000 (1
rounding)
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Constant Gross-MarginPercentage NRV Method
Step 3 Deduct separable costs.
Cost of Separable Joint costs
goods sold costs allocated Product
A1 56,441 35,000 21,441 Product B1
162,973 46,500 116,473 Product C1
113,587 51,500 62,087 Total 333,000 1
33,000 200,000
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Constant GM NRV method

• Something that causes most students to pause
  can happen when using this method to allocate
  joint costs, what is it????

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Approach 2 PhysicalMeasure Method Example
200,000 joint cost
20,000 pounds A
48,000 pounds B
12,000 pounds C
Product A 50,000
Product B 120,000
Product C 30,000
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Choosing a Method
Why is the sales value at splitoff method widely
used?
It measures the value of the joint
product immediately.
It does not anticipate subsequent
management decisions.
It uses a meaningful basis.
It is simple.
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Choosing a Method
The purpose of the joint-cost allocation
is important in choosing the allocation method.
The physical-measure method is a more appropriate
method to use in rate regulation.
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Avoiding Joint Cost Allocation
Some companies refrain from allocating
joint costs and instead carry their
inventories at estimated net realizable
value. (This is the ceiling of LCM rule. What
is the floor?)
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Irrelevance of Joint Costsfor Decision Making
Assume that products A, B, and C can be sold at
the splitoff point or processed further into A1,
B1, and C1.
Selling Selling Additional
Units price (1) price (2)
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 (1) value at splitoff (2) value
after processing further.
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Irrelevance of Joint Costsfor 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)
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Accounting for Byproducts
Method A The production method recognizes
byproducts at the time their production is
completed.
Method B The sale method delays recognition
of byproducts until the time of their sale.
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Accounting for Byproducts
Neither approach is conceptually correct. Both
technically violate GAAP.
Method A Recognizes byproducts revenue at the
time their production is completed. Method
B Does not recognize byproducts in inventory.
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Accounting for Byproducts
Byproducts have low sales value. Cost-benefit
analysis often times leads to the use of the most
expedient method.
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Accounting for Byproducts
An alternative approach that would follow GAAP
would be to treat byproducts as if they were
joint products (i.e., use the same joint cost
allocation method for all products.
This is not common practice, why?
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Accounting for Byproducts

• Byproduct revenues appear in the income statement
  as either
• Cost reduction for the main product, or
• Separate item of revenue or other income.

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End of Chapter 16