Cost Allocation: Joint Products and Byproducts CHAPTER 16 Cost Allocation: Joint Products and Byproducts

Joint Cost Terminology Joint costs—costs of a single production process that yields multiple products simultaneously Splitoff 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

Joint Cost Terminology Categories of joint process outputs: Outputs with a positive sales value Outputs with a zero sales value Product—any output with a positive sales value, or an output that enables a firm to avoid incurring costs Value can be high or low

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

Joint Cost Terminology Byproducts—outputs of a joint production process that have low sales values compare to the sales values of the other outputs

Examples of Joint Cost Situations

Joint Process Overview

Reasons for Allocating Joint Costs Required for GAAP and taxation purposes Computation of inventoriable costs and cost of goods sold for financial accounting and tax reporting Internal analysis of divisional profitability Cost-based contracting Insurance settlements Required for rate and price regulations Litigation

Joint Cost Allocation Methods Market-based—allocate using market-derived data (dollars): Sales value at splitoff Net realizable value (NRV) Constant gross-margin percentage NRV Physical measures—allocate using tangible attributes of the products, such as pounds, gallons, barrels, and so on

Sales Value at Splitoff Method Uses the sales value of the entire production of the accounting period to calculate allocation percentage Ignores inventories

Joint Cost Illustration Data

Joint Cost Illustration Overview

Sales Value at Splitoff Illustration

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

Net Realizable Value Method Overview

Net Realizable Value Method Illustrated

Net Realizable Value Method Illustrated

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.

Constant Gross Margin NRV Illustrated

Physical-Measure Method Allocates joint costs to joint products on the basis of the relative weight, volume, or other physical measure at the splitoff point of total production of the products

Physical Measures Illustration

Method Selection If selling price at splitoff 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.

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 costs. Don’t assume all separable costs in joint-cost allocations are always incremental costs. Some separable costs may be fixed costs. Separable costs need to be evaluated for relevance individually .

Sell-or-Process Further Flowchart

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

Byproducts Illustration Overview

Comparative Income Statements for Accounting for Byproducts