1. Cost Allocation: Joint Products and Byproducts Chapter 16

2. Learning Objective 1 Identify the splitoff point(s) in a joint-cost situation.

3. A Better Picture

4. Joint-Cost Basics Joint productsJoint costs Separable costs Splitoff point Byproduct

5. Joint Processes JOINT PROCESS COMMON IMPUT SPLIT-OFF POINT Point at which joint-products appear FINAL PRODUCT One that is ready for sale without further processing Simultaneously converts a common input into several outcomes INTERMEDIATE PRODUCT A product that requires further processing before it is salable to the public JOINT COSTS Costs to operate joint processes INTERMEDIAT E PRODUCT A INTERMEDIAT E PRODUCT B FINAL PRODUCT A FINAL PRODUCT B

6. Joint-Cost Basics Raw milk CreamLiquidSkim

7. Joint-Cost Basics Coal GasBenzylTar

8. Learning Objective 2 Distinguish joint products from byproducts.

9. Joint Products and Byproducts Sales Value High Low Main Products Joint Products Byproducts

10. Learning Objective 3 Explain why joint costs should be allocated to individual products.

11. Why Allocate Joint Costs? Organizations Allocate Joint Costs for Many Reasons Measuring Performance Estimating Casualty Losses Determining and Responding to Regulatory Rates Specifying and Resolving Contractual Interests and Obligations Valuing Inventories for Financial and Tax Reporting Valuing Cost of Goods Sold for Financial and Tax Reporting

12. Learning Objective 4 Allocate joint costs using four different methods.

13. Approaches to Allocating Joint Costs Approach 2: Physical measure Approach 1: Market based Two basic ways to allocate joint costs to products are:

14. Approach 1: Market-based Data Sales value at splitoff method Estimated net realizable value (NRV) method Constant gross-margin percentage NRV method

15. Allocating Joint Costs Example 10,000 units of A at a selling price of $10 = $100,000 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 Joint processing cost is $200,000 Splitoff point

16. Sales Value at Splitoff Method 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

17. Sales Value at Splitoff Method 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 percentage of each product?

18. Sales Value at Splitoff Method 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

19. Sales Value at Splitoff Method 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%

20. 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

21. Estimated Net Realizable Value (NRV) Method Example Additional processing (separable) costs are as follows: A1: $35,000 B1: $46,500C1: $51,500 What is the estimated net realizable value of each product at the splitoff point?

22. 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?

23. 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

24. Estimated Net Realizable Value (NRV) Method Example AllocatedSeparableInventory 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

25. Constant Gross-Margin Percentage 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.

26. Constant Gross-Margin Percentage NRV Method Step 3: Deduct the expected separable costs from the total costs to obtain the joint-cost allocation.

27. Constant Gross-Margin Percentage 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

28. Constant Gross-Margin Percentage 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%

29. Constant Gross-Margin Percentage 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)

30. Constant Gross-Margin Percentage 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$133,000$200,000

31. Approach 2: Physical Measure 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

32. Learning Objective 5 Explain why the sales value at splitoff method is preferred when allocating joint costs.

33. 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.

34. 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.

35. Avoiding Joint Cost Allocation Some companies refrain from allocating joint costs and instead carry their inventories at estimated net realizable value.

36. Learning Objective 6 Explain why joint costs are irrelevant in a sell-or-process-further decision.

37. Sell or Process Further Joint costs of processing to split-off point $$$$ Split-off point Joint products Raw materials

38. Irrelevance of Joint Costs for Decision Making Assume that products A, B, and C can be sold at the splitoff point or processed further into A1, B1, and C1. SellingSelling Additional Units price price costs 10,000A: $10A1: $12$35,000 10,500B: $30B1: $33$46,500 11,500C: $20C1: $21$51,500

39. Irrelevance of Joint Costs for 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)

40. Sell or Process Further Example

42. Learning Objective 7 Account for byproducts using two different methods.

43. B: Consider by-product NRV as other revenue A: Deduct by-product NRV from costs of main products By-products are minor products and alternative methods are not likely to have a material effect on the financial statements for internal or external reporting. Whether to sell the by-product at split-off or process it further usually depends on the highest NPR obtainable, just as for a main product. Two standard methods By-Product Accounting: the Basics

44. 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.

45. Accounting for Byproducts Example Main Products Byproducts (Yards) (Yards) Production1,000400 Sales 800300 Ending inventory 200100 Sales price$13/yard$1.00/yard No beginning finished goods inventory

46. Accounting for Byproducts Example 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

47. Accounting for Byproducts Method 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

48. Accounting for Byproducts Method 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

49. Accounting for Byproducts Method 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%

50. Accounting for Byproducts Method A What are the inventoriable costs? Main product: 200 ÷ 1,000 × $8,600 = $1,720 Byproduct: 100 × $1.00 = $100

51. Journal Entries Method A Work in Process2,000 Accounts Payable2,000 To record direct materials purchased and used in production Work in Process7,000 Various Accounts7,000 To record conversion costs in the joint process

52. Journal Entries Method A Byproduct Inventory 400 Finished Goods8,600 Work in Process9,000 To record cost of goods completed Cost of Goods Sold6,880 Finished Goods6,880 To record the cost of the main product sold

53. Journal Entries Method A Cash or Accounts Receivable10,400 Revenues10,400 To record the sale of the main product Cash or Accounts Receivable 300 Byproduct Inventory300 To record the sale of the byproduct

54. Accounting for Byproducts Method 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.

55. Accounting for Byproducts Method B Income Statement (Method B) Revenues: Main product (800 × $13)$10,400 Byproducts sold 300 Total revenues$10,700 Cost of goods sold: Joint production costs9,000 Less main product inventory1,800$ 7,200 Gross margin$ 3,200

56. Accounting for Byproducts Method 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-

57. Journal Entries Method B Work in Process2,000 Accounts Payable2,000 To record direct materials purchased and used in production Work in Process7,000 Various Accounts7,000 To record conversion costs in the joint process

58. Journal Entries Method B Finished Goods9,000 Work in Process9,000 To record cost of goods completed Cost of Goods Sold7,200 Finished Goods7,200 To record the cost of the main product sold

59. Journal Entries Method B Cash or Accounts Receivable10,400 Revenues10,400 To record the sale of the main product Cash or Accounts Receivable 300 Revenues 300 To record the sale of the byproduct

60. End of Chapter 16