Cost Allocation: Joint Products and Byproducts

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Cost Allocation Joint Productsand Byproducts

• Chapter 16

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Learning Objective 1
Identify the split-off point(s) in a joint-cost
situation.
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Joint-Cost Basics (E.g. 1)
Split-off point
Joint costs are costs Incurred in producing the
raw milk
Raw milk
Separable costs are costs incurred in producing
these separately identifiable products
Cream
Liquid Skim
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Joint-Cost Basics (E.g. 2)
Coal
Gas
Benzyl
Tar
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Learning Objective 2
Distinguish joint products from byproducts.
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Joint Products and Byproducts
Main Product 1 Joint Products 2
Byproducts
High
Low
Sales Value
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Learning Objective 3
Explain why joint costs should be allocated to
individual products.
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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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Learning Objective 4
Allocate joint costs using four different methods.
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Approaches to AllocatingJoint Costs
Two (2) 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 methods
(1) - Sales value at split-off method
(2) - Estimated net realizable value (NRV) method
(3) - Constant gross-margin percentage NRV method
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(1) Sales Value at Split-offMethod 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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(1) Sales Value at Split-offMethod Example
A B C
Total Sales Value 100,000 315,000 230,000
645,000 Allocation 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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(1) Sales Value at Split-offMethod Example
Assume all of the units produced of B and C were
sold.
2,500 units of A (25) remain in inventory.
What is the gross margin of product A ? What is
the gross margin percentage of each product?
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(1) Sales Value at Split-offMethod Example
Product A Revenues 7,500 units
10.00 75,000 Cost of goods sold Joint
product costs 31,008 Less ending
inventory 31,008 25 7,752
23,256 Gross margin 51,744
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(1) Sales Value at Split-offMethod Example
Product A (75,000 23,256) 75,000 69
Product B (315,000 97,674) 315,000 69
Product C (230,000 71,318) 230,000 69
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(2) Estimated Net Realizable Value(NRV) Method
Example
Assume that Oklahoma 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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(2) 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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(2) 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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(2) Estimated Net Realizable Value(NRV) Method
Example
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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(2) 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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(3) 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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(3) 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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(3) 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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(3) 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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(3) 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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(3) 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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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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Learning Objective 5
Explain why the sales value at splitoff method is
preferred when allocating joint costs.
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Choosing a Method
Why is the sales value at split-off 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 NRV method should be used when there is not
enough information about individual selling
prices at split-off point.
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.
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Learning Objective 6
Explain why joint costs are irrelevant in
a sell-or-process-further decision.
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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 price costs 10,000 A 10 A1
12 35,000 10,500 B 30 B1
33 26,500 11,500 C 20 C1 21 51,500
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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 26,500 5,000
Product C Incremental revenue 11,500
Incremental cost 51,500 (40,000)
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Irrelevance of Joint Costsfor Decision Making
Should A, B, or C be sold at the splitoff point
or processed further?
Split-off
Product A Incremental revenue 20,000
Incremental cost 35,000 (15,000)
Product B Incremental revenue 31,500
Incremental cost 26,500 5,000
Processed further
Product C Incremental revenue 11,500
Incremental cost 51,500 (40,000)
Split-off
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Learning Objective 7
Account for byproducts using two different
methods.
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Accounting for Byproducts
Method A The production method recognizes
byproducts at the time their production is
completed. (Conceptually, this is the correct
method)
Method B The sale method delays recognition
of byproducts until the time of their sale.
(used when dollar amount of byproducts are
immaterial)
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Accounting for ByproductsExample
Main Products Byproducts
(Yards) (Yards) Production 1,000 400 Sa
les 800 300 Ending inventory
200 100 Sales price 13/yard 1.00/yard N
o beginning finished goods inventory
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Accounting for ByproductsExample
Joint production costs for joint (main) products
and byproducts
Material 2,000 Manufacturing labor
3,000 Manufacturing overhead 4,000 Total
production cost 9,000
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Accounting for ByproductsMethod A
Method A The production method
What is the value of ending inventory of joint
(main) products?
9,000 total production cost 400 net
realizable value of the byproduct 8,600 net
production cost for the joint products
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Accounting for ByproductsMethod A
200 1,000 8,600 1,720 is the
value assigned to the 200 yards in ending
inventory.
What is the cost of goods sold?
Joint production costs 9,000 Less
byproduct revenue 400 Less main product
inventory 1,720 Cost of goods
sold 6,880
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Accounting for ByproductsMethod A
Income Statement (Method A)
Revenues (800 yards 13) 10,400 Cost of goods
sold 6,880 Gross margin 3,520
What is the gross margin percentage?
3,520 10,400 33.85
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Accounting for ByproductsMethod A
What are the inventoriable costs?
Main product 200 1,000 8,600 1,720
Byproduct 100 1.00 100
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Journal Entries Method A
Work in Process 2,000 Accounts
Payable 2,000 To record direct materials
purchased and used in production

• Work in Process 7,000
• Various Accounts 7,000
• To record conversion costs in the joint process

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Journal Entries Method A
Byproduct Inventory 400 Finished
Goods 8,600 Work in Process 9,000 To
record cost of goods completed
Cost of Goods Sold 6,880 Finished
Goods 6,880 To record the cost of the main
product sold
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Journal Entries Method A
Cash or Accounts Receivable 10,400 Revenues
10,400 To record the sale of the main
product
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Accounting for ByproductsMethod B
Method B The sale method
What is the value of ending inventory of joint
(main) products?
200 1,000 9,000 1,800
No value is assigned to the 400 yards
of byproducts at the time of production.
The 300 resulting from the sale of byproducts is
reported as revenues.
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Accounting for ByproductsMethod B
Income Statement (Method B)
Revenues Main product (800 13) 10,400 Byprod
ucts sold 300 Total
revenues 10,700 Cost of goods
sold Joint production costs 9,000 Less main
product inventory 1,800 7,200 Gross
margin 3,200
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Accounting for ByproductsMethod B
What is the gross margin percentage?
3,200 10,700 29.91
What are the inventoriable costs?
Main product 200 1,000 9,000
1,800 By-product -0-
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Journal Entries Method B
Work in Process 2,000 Accounts
Payable 2,000 To record direct materials
purchased and used in production
Work in Process 7,000 Various
Accounts 7,000 To record conversion costs
in the joint process
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Journal Entries Method B
Finished Goods 9,000 Work in
Process 9,000 To record cost of goods
completed
Cost of Goods Sold 7,200 Finished
Goods 7,200 To record the cost of the main
product sold
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Journal Entries Method B
Cash or Accounts Receivable 10,400 Revenues
10,400 To record the sale of the main product
Cash or Accounts Receivable
300 Revenues 300 To record the
sale of the byproduct
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End of Chapter 16