Cost Allocation : Joint Products and Byproducts 관리회계2001 Cost Allocation : Joint Products and Byproducts

Learning Objectives 1. Identify the splitoff point(s) in a joint-cost situation 2. Distinguish between joint products and byproducts 3. Provide several reasons for allocating joint costs to individual products 4. Distinguish alternative methods of allocating joint costs

Learning Objectives 5. Describe why the sales value at splitoff method is widely used 6. Describe the irrelevance of joint costs in deciding to sell or process further 7. Distinguish alternative methods of accounting for byproducts

Joint Products, Main Products, Byproducts, and Scrap Scraps High Low Minimal Relative Sales Value

Joint Process Joint Costs Joint Process is a single process that yields multiple products simultaneously Joint Costs The costs of joint process

Joint Process A A’ B B’ C Processing Raw Materials Processing Joint Costs Separable Costs Splitoff Point

Joint Process

Examples Joint-Cost Situations Separable Products at the Splitoff Point Industry Agriculture Lamb Raw milk Turkey farm Lamb cuts, tripe, hides, bones, fat Cream, liquid skim Breast, wings, thighs, drumsticks, digest, feathermeal, and poultrymeal Extractive Industry Coal Copper ore Petroleum Salt Coke, gas, benzole, tar ammonia Copper, silver, lead, zinc Crude oil, gas, raw LPG Hydrogen, chlorine, caustic soda Chemical Industry Raw LPG Butane, ethane, propane

Why Allocate Joint Costs ? Inventory costing and COGS computations for external financial statements and reports for income tax authorities Inventory costing and COGS computations for internal reporting. Such reports are used in division profitability analysis when determining compensation for divisional managers. Cost reimbursement under contracts when only a portion of a business’s product or services is sold or delivered to a single customer(such as a government agency).

Why Allocate Joint Costs ? Customer profitability analysis where individual customers purchase varying combinations of joint products or byproducts as well as products of the company. Insurance settlement computations when damage claims made by business with joint products, main products, or byproducts are based on cost information. Rate regulation when one or more of the jointly produced products or services are subject to price regulation.

Approaches to Allocating Joint Costs Allocate costs using market-based data The sales value at splitoff method The NRV method The constant gross-margin percentage NRV method Allocate costs using physical measure -based data No allocation

Example 1 : Farmers Dairy SALES 20 gallons @$8 Cream 25 gallons Processing $400 Raw Milk 110 gallons LiquidSkim 30 gallons @$4 Joint Costs 75 gallons Splitoff Point

Sales Value at Splitoff Method Cream $400*[25*8/(25*8+75*4)] = $160 관리회계2001 Sales Value at Splitoff Method Cream $400*[25*8/(25*8+75*4)] = $160 Liquid Skim $400*[75*4/(25*8+75*4)] = $240 Physical Measure Method Cream $400*[25/(25+75)] = $100 Liquid Skim $400*[75*/(25+75)] = $300

Example 2 : Farmers Dairy Butter Cream Cream Processing $280 Raw Milk 110 gallons Processing $400 25 gallons 20 gallons @$25 LiquidSkim Processing $520 Condensed Milk 75 gallons 50 gallons @$22 Joint Costs Separable Costs Splitoff Point

Estimated Net Realizable Value Method 관리회계2001 Estimated Net Realizable Value Method Butter Condensed Cream Milk Total 1. Expected final sales value of production 2. Deduct expected separable costs to complete and sell 3. Estimated NRV at splitoff point 4. Weighting 5. Joint costs allocated 6. Production costs per gallon $500 280 $220 0.275 $110 $19.50 $1,100 520 $ 580 0.725 $290 $16.20 $1,600 800 $ 800 $400

Constant Gross-Margin Percentage NRV Method 관리회계2001 Constant Gross-Margin Percentage NRV Method Step 1 : Compute overall gross-margin percentage Expected final sales value of production $1,600 Deduct joint and separable costs($400+$280+$520) 1,200 Gross margin $ 400 Gross margin percentage 25%

Constant Gross-Margin Percentage NRV Method 관리회계2001 Constant Gross-Margin Percentage NRV Method Butter Condensed Cream Milk Total Step 2 : Compute total costs that each product should bear Expected final sales value of production Deduct gross margin(25%) Cost of goods sold $500 125 $375 $1,100 275 $ 825 $1,600 400 $1,200 Step 3 : Allocate joint costs Deduct separable costs Joint costs allocated 280 $ 95 520 $ 305 800 $ 400

Comparison of Methods The benefits-received criterion leads to a preference for the sales value at splitoff point method (or other related revenue or market-based methods). Additional benefits of this method include : 1. No anticipation of subsequent management decisions. 2. Availability of a meaningful common denominator to compute the weighting factors. 3. Simplicity. The purpose of the joint-cost allocation is important.

Use of Joint-Cost-Allocation Methods (%) Physical measure m. Sales value method Negotiated basis Not allocated Other 60 6 10 8 27 45 28 10 76 5 19 10 14 Source : Blayney and Yokohama(1991)

Joint-Cost-Allocation Methods Used by U.K. Companies 관리회계2001 Joint-Cost-Allocation Methods Used by U.K. Companies Predominant Joint-Cost- Allocation Method Used Type of Company Petrochemicals Sales value at splitoff point or Estimated NRV Coal Processing Physical measure Coal Chemicals Physical measure Oil Refining No allocation of joint costs

Example 3 : Fragrance, Inc. Mystique Specialty Chemical Processing $880 50 ounces @$6 Processing $160 Passion Romance 150 ounces @$4 100 ounces @$8 Joint Costs Separable Costs Splitoff Point

Joint Costs and Decision Making Decision to further process or not Incremental revenue of Romance (100*$8)-(150*$4) $200 Incremental costs of Romance 160 Incremental operating income from converting Passion into Romance $ 40 It is profitable to extend processing and to incur additional costs on a joint product as long as the incremental revenue exceeds incremental costs.

Accounting for Byproducts When are byproducts first recognized in the general ledger ? When do byproducts revenues appear in the income statement ?

Accounting for Byproducts Timing of Recognition Presented in I/S Presented in B/S Production Sale Reduction of cost Revenue or other income item Byproducts inventory reported at selling prices Byproducts inventory not recognized

Example 4 : Meatworks Group SALES 400 @$60 Shoulder Meat 500 Processing $25,000 Lam Shoulders 30 @$4 Hock Meat Joint Costs 100 Splitoff Point

Method A : Byproducts Recognized at Time Production is Completed 1. To record manufacturing costs Work-in-Process 25,000 Various accounts 25,000 2. To record costs of goods completed Byproduct Inventory-Hock Meat(100*$4) 400 Finished Goods-Shoulder Meat($25,000-$400) 24,600 Work in Process 25,000 3. To record the cost of main product sold Cost of Goods Sold[$24,600*(400/500)] 19,680 Finished Goods-Shoulder Meat 19,680

Method A : Byproducts Recognized at Time Production is Completed 4. To record the sales of main product Cash or Accounts Receivable(400*$60) 24,000 Revenues-Shoulder Meat 24,000 5. To record the sales of the byproduct Cash or Accounts Receivable(30*$4) 120 Byproduct Inventory-Hock Meat 120

Method B : Byproducts Recognized at Time of Sales 1. To record manufacturing costs Work-in-Process 25,000 Various accounts 25,000 2. To record costs of goods completed Finished Goods-Shoulder Meat 25,000 Work in Process 25,000 3. To record the cost of main product sold Cost of Goods Sold[$25,000*(400/500)] 20,000 Finished Goods-Shoulder Meat 20,000

Method B : Byproducts Recognized at Time of Sale 4. To record the sales of main product Cash or Accounts Receivable(400*$60) 24,000 Revenues-Shoulder Meat 24,000 5. To record the sales of the byproduct Cash or Accounts Receivable(30*$4) 120 Revenue-Hock Meat 120

Income Statement of Meatworks Group 관리회계2001 Income Statement of Meatworks Group