Don R. Hansen Maryanne M. Mowen COST MANAGEMENT Don R. Hansen Maryanne M. Mowen

Joint Product and By-Product Costing Chapter Seven Joint Product and By-Product Costing

Learning Objectives Identify the characteristics of the joint production process. Allocate joint product costs according to benefits-received approaches and the relative market value approaches. Describe methods of accounting for by-products.

Learning Objectives (continued) Explain why joint cost allocations may be misleading in management decision making. Discuss why joint production is seldom found in service industries.

Joint Production Process Pork Meat Raw Material: Hog Processing Hides Split-Off Point

Independent Multiple-Product Production Processing Mustang Raw Material: Steel Processing Taurus

Joint Production Process Joint products are two or more products produced simultaneously by the same process up to a “split-off” point. The split-off point is the point at which the joint products become separate and identifiable. Separable costs are easily traced to individual products and offer no particular problem.

Joint Production Costs (Manufacturing perfume) Separable Costs Joint Costs Processing $100,000 Charm: 10,000 ounces @ $40 per ounce Processing $400,000 Oil Wild Scent: 20,000 ounces @ $10 per ounce Processing $300,000 (Flower Oil) Wild Flower: 50,000 ounces @ $1 per ounce

By-Product Costs Characteristics By-product resulting from scrap, trimmings, and so forth, of the main products in essentially nonjoint-product types of undertakings (e.g., fabric trimmings from clothing pieces). Scrap and other residue from essentially joint-product types of processes (e.g., fat trimmed from beef carcasses). A minor joint product situation (fruit skins and trimmings used as animal feed).

By-Products The distinction between joint and by-products rests solely on the relative importance of their sales value. A by-product is a secondary product recovered in the course of manufacturing a primary product.

Examples of Joint Products and By-Products Industry Joint Products and By-products Agriculture and Food Industries Flour milling Patent flour, clear flour, middlings, bran, and wheatgem Extractive Industries Copper mining Copper, gold, silver, and other metals Chemical Industries Soap making Soap and glycerine Manufacturing Cement Concrete pipe and aggregate

Accounting For Joint Product Costs Methods Benefits-Received Approaches Physical Units Method Weighted Average Method Allocation Based on Relative Market Value Sales-Value-at-Split-Off-Method Net Realizable Value Method

Joint Costs Example An Example: Suppose that a sawmill processes logs into four grades of lumber totaling 3,000,000 board feet as follows. Board Weight Price at Split-Off Grades Feet Factor (per 1,000 ft.) 1 450,000 1.30 $300 2 1,200,000 1.10 200 3 600,000 1.00 121 4 750,000 .50 70 Total 3,000,000 ======= Total joint cost is $186,000

The Physical Units Method Board Joint Cost Grades Feet % of Units Allocation 1 450,000 .15 $ 27,900 2 1,200,000 .40 74,400 3 600,000 .20 37,200 4 750,000 .25 46,500 Total 3,000,000 $186,000 ======= =======

Weighted Average Method Board Weight Weighted # Allocated Grades Feet Factor of Board Feet Percent Joint Cost 1 450,000 1.30 585,000 .2031 $ 37,776 2 1,200,000 1.10 1,320,000 .4583 85,244 3 600,000 1.00 600,000 .2083 38,744 4 750,000 .50 375,000 .1302 24,217 Totals 3,000,000 2,880,000 100.00 *$186,000 ======= ======= ===== ======= * Rounding Error Grades with higher weights require more cost to obtain the required finish and quality appearance.

Sales-Value-At-Split-off Method Board Price at Sales Value Allocated Grades Feet Split-Off at Split-off Percent Joint Cost 1 450,000 $300 $135,000 .2699 $ 50.201 2 1,200,000 200 240,000 .4799 89,261 3 600,000 121 72,600 .1452 27,007 4 750,000 70 52,500 .1050 19,530 Totals 3,000,000 $500,100 100.00 *$186,000 ======= ====== ===== ====== *Rounding Error

Net Realizable Value Method An Example: Suppose that a company manufactures two products, Alpha and Beta, from a joint process. One production run costs $5,750 and results in 1,000 gallons of Alpha and 3,000 gallons of Beta. Neither product is salable at split-off, but must be further processed . The separable costs for Alpha is $1 per gallon and for Beta is $2 per gallon. The eventual market price for Alpha is $5 and for Beta $4. Further Hypothetical Hypothetical Market Processing Market Number Market Allocated Price Cost Price of Units Value Joint Cost Alpha $5 $1 $4 1,000 $4,000 $2,300 Beta 4 2 2 3,000 6,000 3,450 $10,000 $5,750

Constant Gross Margin Percentage Method Using data from the previous example: Revenue [($5 x 1,000) + ($4 x 3,000)] $17,000 100 % Costs [$5,750 + ($1 x 1,000) + ($2 x 3,000)] 12,750 75 Gross profit $ 4,250 25 % Alpha Beta Eventual market value $5,000 $12,000 Less: Gross margin @ 25% 1,250 3,000 Cost of goods sold $3,750 $ 9,000 Less: Separable costs 1,000 6,000 Allocated joint costs $2,750 $ 3,000 ===== =====

Sales-To-Production-Ratio Method Assume that $1,000,000 of joint cost was allocated to five products based on the sales-to-production ratio. Note that under this method, less cost is assigned to slower moving goods like Product C, which accounted for 25% of production by only 15% of sales. A good like Product B, which accounted for just 15% of production but 20% of sales, receives relatively more joint cost. The end result is that relatively higher production cost is matched against current revenues, and the company claims lower net income for tax purposes. %of % of Sales-to-Production Cost Assigned Product Total Sales Production Ratio Percent Sales/Prod. A 10 10 1.0000 19.9338 $ 199,338 B 20 15 1.3333 26.5778 265,778 C 15 25 0 .6000 11.9603 119,603 D 40 30 1.3333 26.5778 265,778 E 15 20 0.7500 14.9504 149,504 100 100 5.0166 *100.000 $1,000,001 === === ===== ====== ======== *Rounding error

Accounting for By-Product Costs Given for a main product and a by-product: Total manufacturing costs of main product and by-product $22,000 Total sales of main product 25,000 Estimated net realizable value of by-product produced 2,000 Beginning inventories (including ending inventory of by-product) None Ending inventory of main product is 25% of production volume Ending inventory of by-product is 10% of production volume

Accounting for By-Product Costs (continued) Sales of main product $25,000 Cost of goods sold: Total manufacturing costs $22,000 Deduct net revenue of byproduct (90% x $2,000) 1,800 Net manufacturing costs $20,200 Deduct main product inventory (25% x 20,200) 5,050 Deduct byproduct inventory (10% x $2,000) 200 14,950 Gross margin $10,050 ====== By-product revenue is treated as a reduction of main product manufacturing costs.

Accounting for By-Product Costs (continued) Sales of main product $25,000 Add net revenue of byproduct (90% x $2,000) 1,800 Total Sales $26,800 Cost of goods sold: Total manufacturing costs $22,000 Deduct main product inventory (25% x 22,000) 5,500 Deduct byproduct inventory (10% x $2,000) 200 16,300 Gross margin $10,500 ====== By-product revenue is treated as a separate revenue item.

Effect of Joint Product Costs on Cost Control and Decision Making It is important to understand when the use of allocated joint product costs may be misleading. In making decisions relative to jointly produced articles, it must be remembered that the products are necessarily produced jointly. Some areas that can be affected by joint cost allocations are: Output decisions Further processing of joint products Pricing jointly produced products

End of Chapter 7