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CMA2 - Supplementary Notes: Cost Allocation: Joint Products and

By Products

1. Definitions
a. Joint Cost: the cost of a single process that yield multiple products
simultaneously. Includes DM, DL, and mfg. Ohd up to the split-off point
b. Split-off Point: the point in the process at which the products become
separately identifiable.
c. Separable Costs: those costs incurred beyond the split-off point that are
identifiable with individual products
d. Main Product: the product with the highest sales value relative to other
products beyond split-off
e. Joint Products: other products with a relative high sales value that are
not identifiable as individual products until the split-off point
f. Byproduct: a product beyond the split-off point with a relatively low
sales value in comparison with main and joint products
g. Scrap: products beyond split-off with minimal value (May have a negative
sales value if must be hauled away to a landfill)

2. Reasons for Allocating Joint Costs to Individual Products


a. To value inventory and COGS for external reports
b. To value inventory and COGS for internal reports (including profitability
analysis and performance evaluation)
c. For cost reimbursement under contracts where not all the separable products
go to a single customer so that allocation of the joint costs is necessary.
d. For settlement of insurance claims involving separable products at or beyond
split-off.
e. For rate regulation when one or more jointly produced products or services are
subject to rate regulation based on cost. E.g. services using telephone lines

3. Methods of Allocating Joint Costs

a. Methods where a measure is available at the Split-off point for each


separable product.
i. Sales Value at Split-off: This method allocates joint costs to the
separable products based on the relative slaves value of each
product at the split-off point
Includes the sales value of the entire production----not just actual
sales
Simple to apply because it provides a common measure applicable
to all products if sales value is readily available
Also, relates cost allocated to the revenue-generating power of
individual products. Demo 15-16
ii. Physical Measures Method: This method uses some measure of
weight of volume common to all separable products at the split-off
point.
The problem with this method is that the physical measure may
bear no relationship to the revenue producing power of the
separable products. For example, if a company mines gold and
lead, an ounce of gold will be much more valuable than an ounce
of lead but both would get the same allocation when ounces is used
as the measure. This causes high value items per unit of the
physical measure to show high profits and low value items per unit
of the physical measure to show low profits. Demo 15-16

b. Methods where there isn’t a market for all of the separable products at
split-off. Therefore, some other method has to be used that
approximates the situation at the split-off point. (The
allocation must relate to the situation at split-off because joint costs cease
to have meaning beyong the splitoff point). There are two methods that
can approximate the situation at split-off.
i. Estimated Net Realizable Value Method (NRV)
The NRV for each product as a % of the total NRV of all products,
is the basis for the allocation.
Est’d NRV = Final sales value of production – Separable Costs
(to get an estimated NRV for all products combined that is
approximately equal to joint costs, you would also need to deduct
selling and admin expenses and gross profit. This is not usually
done in practice just to keep things simple)

iii. Constant Gross Profit % NRV Method


This method assumes every separable product earns the same GP%
(this may not be very realistic) It starts with the final sales value of
production and subtracts the Gross Profit (which is equal to Sales x
constant GP%), and then subtracts the Separable Costs. The
result is an approximation of the Joint Costs for each separable
product at split-off.
Steps:
1. Compute the overall GP% (called the constant GP%) for
all products combined (i.e., GP = FSVP – JC – SC
2. Calculate the GP in $ for each product (i.e., FSVP x
constant GP% determined in part 1.)
3. Calculate the Joint Costs for each product as follows:
FSVP xx
Less: GP in $ (xx)
Less Sep. Costs (xx)
= Joint Costs allocated xx
Note: Some products may end up with a negative
allocation of Joint costs;
Accounting for By-products

A by-product is a product having a relatively low sales value compared with the main
or joint products; by-products can be sold at split-off or processed further; also, if
sales increase, a by-product may be re-classified as a joint product at some point.

There are several methods of accounting for by-products in terms or recognizing when to
record the cost of the by-product. We will recognize the cost of the by-product only
when production is completed.

Steps:
1. Calculate the NRV of the by product (i.e., FSVP – SC, or sometimes if specified,
FSVP – SC – normal GP).
2. Subtract this NRV of the by-product from the total joint cost and set the amount
up as by-product inventory.

By-product inventory xxx


Joint costs xxx

3. Allocate the revised joint cost in the usual way to the joint products using one of
the four methods
4. Record any sales of the by-product as follows:

A/R xxx
By product inventory xxx

Note: Because the NRV of the by-product is treated as a reduction in the total
joint cost allocation and because the by-product is given no status as a separate
product, there is no Sales a/c and no COGS a/c for the by-product
itself------only Balance Sheet accounts.

The sales of the by-product are either added to the sales of the other joint products
or deducted from the COGS of the other joint products. These Sales or COGS
adjustments are done on the financial statement and not in the accounting records.
(This procedure assumes that the selling price and inventory cost per unit of the
by-product are both valued at the NRV per unit of the by-product)

RF 03/05