Allocation of Joint Costs and Accounting for By-Product/Scrap

Terminology

Approximated net realizable value at split-off allocation: a method of allocating joint costs to joint
products using a simulated net realizable value at the split-off point; approximated value is computed as
final sales price minus incremental separate costs
By-product: an incidental output of a joint process; it is salable, but the sales value is not substantial
enough for management to justify undertaking the joint process; it is viewed as having a higher sales
value than scrap
Joint costs: costs incurred for material, labor, and overhead during a joint process up to the split-off point
Joint process: a process during which one product cannot be manufactured without producing others
Joint product: a primary output of a joint process; each joint product individually has substantial
revenue-generating ability

Net realizable value (NRV): an amount equal to the product’s sales revenue at split-off less preparation
and disposal costs
Net realizable value approach: a method of accounting for by-products or scrap that requires that the
net realizable value of these products be treated as a reduction in the cost of the primary products
Net realizable value at split-off allocation: a method of assigning joint costs to joint products based on
the sales value at split-off minus all costs necessary to prepare and dispose of the products; it requires
that all joint products be salable at the split-off point
Offset approach: (see net realizable value approach)
Other income approach: (see realized value approach)

Physical measure allocation: a method of allocating a joint cost to products that uses a common
physical characteristic as the proration base
Realized value approach: a method of accounting for by-products or scrap that does not recognize any
value for these products until they are sold; the value recognized upon sale can be treated as other
revenue or income
Sales value at split-off allocation: a method of assigning joint costs to joint products based on the
relative sales value of the products at the split-off point as the proration base; use of this method requires
that all joint products be salable at the split-off point
Scrap: an incidental output of a joint process; it is salable but the sales value from scrap is not enough for
management to justify undertaking the joint process; it is viewed as having a lower sales value than a byproduct;
leftover material that has a minimal but distinguishable disposal value
Separate costs: costs incurred in later stages of production that are assignable to specific primary
products
Split-off point: the point at which the outputs of a joint process are first identifiable as individual products
Waste: a residual output of a production process that has no sales value

A. Introduction
1. Many companies produce and sell multiple products.
2. A joint process is a manufacturing process that simultaneously produces more than one product
line.
a. Classification of joint process output is based on management judgment about the relative
sales value of the outputs and can vary from company to company.
3. Joint cost refers to the costs incurred for material, labor, and overhead during a joint process up
to the split-off point.
a. Although joint costs must be allocated to the primary products to determine financial
statement valuations, such allocations should not be used in making internal decisions.
4. Separate costs are costs incurred in later stages of production that are assignable to specific
primary products.
5. This chapter discusses joint manufacturing processes, their related product outputs, and the
accounting treatment of the costs of those processes.

B. Outputs of a Joint Process

1. The products resulting from a joint process and having a sales value are classified as joint
products, by-products, or scrap.
2. Joint products are the primary outputs of a joint process, each of which has substantial revenuegenerating
ability.
a. Joint products are also called primary products, main products, and co-products.
3. By-products are incidental outputs of a joint process; they are salable, but the sales value of byproducts
is not substantial enough for management to justify undertaking the joint process; they
are viewed as having a higher sales value than scrap.
4. Scrap is an incidental output of a joint process; it is salable, but the sales value from scrap is not
enough for management to justify undertaking the joint process; it is viewed as having a lower
sales value than a by-product; leftover material that has a minimal but distinguishable disposal value.
5. Waste is a residual output of a production process that must be disposed of because it has no
sales value.
6. Over time, a product classification may change because of technology advances, consumer
demand, or ecological factors.
a. New joint products may be developed from a product
b. Joint process output is classified based on management’s judgment about the relative sales
values of outputs.

C. The Joint Process

1. Joint products are typically manufactured in companies using mass production processes and a
process costing accounting method.
2. The split-off point is the point at which the outputs of a joint process are first identifiable as
individual products.
3. Financial reporting requires that all necessary and reasonable costs of production be attached to
products.
a. Joint costs must be allocated to the primary outputs of the production process for inventory
valuation purposes.
4. Costs incurred after split-off are assigned to the separate products for which those costs are
incurred.

D. The Joint Process Decision

a. Management must decide whether the total expected revenues from the sale of the joint
process output are likely to exceed the total expected processing costs of the output. Other
potential costs must be considered in determining if the revenues are expected to exceed the
costs;
b. Managers must compare the net income from this use of resources to the net income that
would be provided by all other alternative uses of company resources if total anticipated
revenues from the “basket” of products exceed the anticipated joint and separate costs.
Management would then decide that this joint production process is the best use of capacity
and would begin production if joint process net income is greater than the net income that
would be provided by other uses;
c. Management must decide how to classify joint process outputs; and Some will be primary; others
will be by-product, scrap, or waste.
d. Management must then decide whether any (or all) of the joint process output will be sold (if
marketable) at split-off or whether it will be processed further. Such decisions should be made only after
considering whether the expected additional revenues from further processing are higher than the expected
additional costs of further processing.
2. Managers must have a reasonable estimate of each joint output’s selling price in order to make
decisions at any potential point of sale. Expected selling prices should be based on both cost and
market factors.

E. Allocation of Joint Cost

a. Physical measure allocation is a method of allocating common costs to products that uses
a common physical characteristic as the proration base.
b. Physical measurement allocation, unlike monetary measure allocation, provides an
unchanging yardstick of output.
c. Physical measures are useful in allocating joint cost to products that have extremely unstable
selling prices.
d. A primary disadvantage of the method is that it ignores the revenue-generating ability of
individual joint products.
e. This allocation process treats each weight unit of output as equally desirable and assigns
each the same per unit cost.
b. Monetary measure allocation uses the following steps to prorate joint costs to joint
products:
Step 1: Choose a monetary allocation base;
Step 2: List each product’s base values;
Step 3: Sum the values in step 2 to obtain a total value for the list;
Step 4: Divide each individual value in step 2 by the total in step 3 to obtain a
numerical proportion for each product. (The sum of these proportions should total
100 percent);
Step 5: Multiply the joint cost by each proportion to obtain the amount to be allocated
to each product; and
Step 6: Divide each product’s prorated joint cost by the number of product units to
obtain a cost per unit for valuation purposes.
c. The sales value at split-off allocation is a method of assigning joint cost to joint
products based on the relative sales values of the products at the split-off point.
Use of this method requires that all joint products are marketable at split-off.
d. The net realizable value at split-off allocation is a method of allocating joint cost to
joint products based on the sales value at split-off minus all costs necessary to prepare
and dispose of the products.Use of this method requires that all joint products be salable at split-off.
e. The approximated net realizable value at split-off allocation is a method of allocating
joint cost to joint products that uses a simulated net realizable value at the split-off point.
Approximated value is computed as final sales price minus incremental separate costs.
Thus, decisions made about further processing affect the values used to allocate joint
cost under this method.

F. Accounting for By-Product and Scrap

1. General
a. Because the distinction between by-product and scrap is one of degree, these categories are
discussed together by presenting several of the treatments found in practice.
i. The appropriate choice of method depends on the magnitude of the net realizable value
of the item and the need for additional processing beyond split-off.
b. As the sales value of the by-product increases, so does the need for inventory recognition.
i. Sales value of the by-product is generally recorded under either the NRV approach or
realized value approach.
2. Net realizable value (NRV) approach
a. The net realizable value approach (or offset approach) is a method of accounting for byproducts
or scrap that requires the net realizable value of such products to be treated as a
reduction in the cost of the primary products.
b. The NRV is debited to inventory and one of two accounts may be credited: WIP Inventory –
Joint Products or Cost of Goods Sold.
c. Although reducing joint cost by the NRV of the by-product/scrap is the traditional method
used to account for such goods, it is not necessarily the best method for internal decision
making or the management of by-products/scrap.
i. The NRV method does not indicate the revenues, expenses, or profits from the byproduct
and thus does not provide sufficient information for managerial decision making.
3. Realized value approach
a. When management considers by-product/scrap to be a moderate source of income, the
accounting and reporting methods used should help managers monitor production and further
processing of the by-product/scrap.
b. The realized value approach (or other income approach) is a method of accounting for byproduct/
scrap that does not recognize any value for these products until they are sold; the
value recognized at the time of sale can be treated as other revenue or as other income.
c. The total sales price of the by-product/scrap is shown on the income statement as other
revenue under the “other revenue” method.
i. Additional processing or disposal costs of the by-product/scrap are included with the cost
of producing the primary products, so little useful information is provided to management
since the cost of producing the by-product/scrap is not matched with the revenues
generated by those items.
d. The net by-product revenue is presented as an enhancement of net income in the period of
sale as “other income” under the “other income” method.
i. By-product/scrap revenue is matched with related storage, further processing,
transportation, and disposal costs.
ii. Since detailed information on financial responsibility and accountability is provided,
control and performance may be improved..
4. With the trend toward more emphasis on cost and quality control, companies are becoming more
aware of the potential value of by-product, scrap, and waste and are devoting time and attention
to developing those innovative revenue sources.

G. By-Product and Scrap in Job Order Costing

1. Job order costing systems can have by-products or scrap even though joint products are not
normally associated with such systems.
2. The value of by-product/scrap in a job order costing system should be credited to manufacturing
overhead if the by-products/scrap value is created by a significant proportion of all jobs
undertaken.
3. The by-product/scrap value, in contrast, can be credited to the specific jobs in process if only a
few specific jobs generate a disproportionate share of the by-products/scrap.

H. Joint Costs in Retail Businesses and Not-for-Profit Organizations

1. Joint costs in retail businesses and not-for-profit (NFP) organizations often do not relate to
production processes but to marketing and promotion activities such as:
a. advertising multiple products;
b. printing multipurpose documents; or
c. holding multipurpose events.
2. Retail businesses may allocate joint costs using either a physical or monetary base.
 a. Joint costs for retail businesses usually relate to advertisements rather than to a process.
b. Retail businesses may decide it is not necessary to allocate joint costs.
3. Although retail businesses may decide that allocating joint cost is not necessary, financial
accounting requires that not-for-profit organizations allocate joint costs among the activities of
fund-raising, offering an organizational program (program activities), or conducting an
administrative function (management and general activities).
4. No specific allocation method is prescribed; only that the method used must be rational and
systematic, result in reasonable allocations, and be applied in the same manner under similar
situations.
a. A major purpose of this allocation process is to ensure that external users of financial
statements are able to determine clearly the amounts spent by the organization for various
activities—especially fundraising.
5. There are three tests that must be met for allocation; if all the tests are not met, all the costs
associated with the joint activity must be charged to fundraising:
a. The purpose test must demonstrate that the activity’s purpose includes accomplishing some
program or management/general function.
i. A critical element under the purpose test is the compensation test. If a majority of
compensation or fees for anyone performing a part of the activity is tied to contributions
raised, the activity automatically fails the purpose criterion and all costs of the activity
must be charged to fundraising.
b. The audience test must demonstrate that the NFP chose the audience because it is suitable
for accomplishing the activity’s program or management/general functions.
c. The content test must demonstrate that the activity’s content supports program or
management/general functions.

TRUE/FALSE
1. Joint costs occur after the split-off point in a production process.
2. Joint costs occur before the split-off point in a production process.
3. Joint costs may be allocated to by-products as well as primary products.
4. The primary distinction between by-products and scrap is the difference in sales value.
5. The primary distinction between by-products and scrap is the difference in volume produced.
6. The point at which individual products are first identifiable in a joint process is referred to as the split-off point.
7. Joint costs include all materials, labor and overhead that are incurred before the split-off point.
8. Two methods of allocating joint costs to products are physical measure allocation and monetary allocation.
10. Allocating joint costs based upon a physical measure ignores the revenue-generating ability of individual products.
11. Allocating joint costs based upon a physical measure considers the revenue-generating ability of individual products.
12. Monetary allocation measures recognize the revenue generating ability of each product in a joint process.
13. The relative sales value method requires a common physical unit for measuring the output of each product.
14. Joint costs may be allocated to main products, but not to by-products.
15. Net realizable value equals product sales revenue at split-off plus any costs necessary to prepare and dispose of the
product.
16. Net realizable value equals product sales revenue at split-off minus any costs necessary to prepare and dispose of the
product.
17. If incremental revenues beyond split-off are less than incremental costs, a product should be sold at the split-off
point.
18. If incremental revenues beyond split-off exceed incremental costs, a product should be processed further.
19. The net realizable value approach requires that the net realizable value of by-products and scrap be treated as a
reduction in joint costs allocated to primary products.
20. Net realizable value is considered to be the best measure of the expected contribution of each product to the
coverage of joint costs.
21. The net realizable value approach is used to account for scrap and by-products when the net realizable value is
insignificant.
22. The net realizable value approach is used to account for scrap and by-products when the net realizable value is
significant.
23. Under the realized value approach, no value is recognized for by-products or scrap until they are actually sold.
24. Under the net realizable value approach, no value is recognized for by-products or scrap until they are actually sold.
25. Not-for-profit entities are required to allocate joint costs among fund-raising, program, and administrative functions.

Multiple Choice Questions

1. A product that results from a joint process may be classified as
a. a joint product.
b. a by-product.
c. scrap.
d. All of the above.

2. Select the incorrect statement from the following.

a. Producing first-quality merchandise and factory seconds in a single operation can be viewed
as a joint process.
b. Waste is a residual output from many production processes whose sales value is comparable
to that of by-products.
c. By-products are distinguished from scrap by their higher sales value.
d. While joint cost allocations are necessary to determine financial statement valuations, such
allocations should not be used in making internal decisions.

3. Select the incorrect statement concerning the split-off point.

a. The split-off point is the point at which joint process outputs are first identifiable as individual
products.
b. If joint output is processed beyond the split-off point, additional costs will be incurred and
must be assigned to the specific products for which those costs were incurred.
c. A single joint process cannot have multiple spit-off points.
d. Output may be sold at the split-off point or processed further and then sold.

4. In joint product costing and analysis, which one of the following costs is relevant when
deciding the point at which a product should be sold in order to maximize profits?
a. Purchase costs of the materials required for the joint products
b. Separable costs after the split-off point
c. Joint costs to the split-off point
d. Sales salaries for the period when the units were produced

5. Before committing resources to a joint process, management must first decide whether
total expected revenue from selling the joint output ‘basket’ of products is likely to exceed the:
a. selling expenses for the goods.
b. joint costs and separate processing costs after split-off.
c. disposal costs for any waste generated.
d. All of the above.

6. When estimating unit selling prices for use in allocating joint production costs, which of the
following should be considered?
a. Competitor prices
b. Consumers’ sensitivity to price changes
c. Costs
d. All of the above

7. All of the following are common monetary measures for allocating joint costs to joint
products except:
a. approximated net realizable value at split-off.
b. gross margin at split-off.
c. net realizable value at split-off.
d. sales value at split-off.

8. LS Company manufactures two products, Product L and Product S in a joint process. The
joint (common) costs incurred are $420,000 for a standard production run that generates 180,000
units of L and 120,000 units of S. Product L sells for $2.40 per unit while Product S sells for $3.90
per unit. Assuming both products are sold at the split-off point, the amount of joint cost of each
production run allocated to Product L on a net realizable value (NRV) basis is:
a. $252,000.
b. $218,400.
c. $201,600.
d. $168,000.

9. Products A and B are manufactured in a joint process. The joint (common) costs incurred
are $252,000 for a standard production run that generates 108,000 gallons of Product A which
sells for $2.40 per gallon and 72,000 gallons of Product B which sells for $3.90 per gallon. If no
additional costs are incurred after the split-off point, the amount of joint cost of each production
run allocated to Product B on a physical measure basis is:
a. $100,800.
b. $140,000.
c. $151,200.
d. $280,800.

10. Products X and Y are manufactured in a joint process. The joint (common) costs incurred
are $420,000 for a standard production run that generates 180,000 gallons of Product X which
sells for $2.40 per gallon and 120,000 gallons of Product Y which sells for $3.90 per gallon. If
additional processing costs beyond the split-off point are $1.40 per gallon for Product X and $0.90
per gallon for Product Y, the amount of joint cost allocated to Product Y on a net realizable value
basis is:
a. $280,000.
b. $252,000.
c. $168,000.
d. $140,000.

11. M Company incurs $10,000,000 in joint costs for its three products. The company
estimates the products’ production, final selling price, and separate costs after split-off as follows:
Estimated Estimated
Product Production Selling Price Separate Cost
Product A 3,000 $2,000 $200
Product B 2,400 $3,000 $500
Product C 1,200 $1,500 $100
How much of the joint costs should be allocated to Product A under the approximated net
realizable value at split-off? (Note: round percentages to zero decimal places.)
a. $4,600,000
b. $4,100,000
c. $1,300,000
d. None of the above

12. P Inc. always generates a certain amount of waste due to the nature of its production
activities regardless of which products it is producing at the time. After production in a recent
month, the company sold $200 of scrap. Which of the following is the correct entry to record the
sale of the scrap using the realized value approach?
a. Cash 200
Manufacturing Overhead 200
b. Cash 200
Finished Goods 200
c. Cash 200
Scrap Inventory 200
d. Cash 200
Work in Process 200

13. Select the incorrect statement concerning the accounting for by-product and scrap.
a. Reducing joint cost by the NRV of the by-product/scrap is the traditional method used to
account for such goods.
b. Regardless of whether a company uses the NRV or the realized value approach, the specific
method used to account for by-product should be established before the joint cost is allocated
to the joint products.
c. Two common methods used to account for by-products are the NRV approach and the
realized value approach.
d. Under the realized value approach, the estimated selling price of the by-product is recognized
prior its actual sale.

14. Not-for-profit organizations may charge the entire cost of a joint activity to fund-raising if all
of the following criteria are met except:
a. amount.
b. audience.
c. content.
d. purpose.

15. If a majority of compensation or fees for anyone performing a part of an activity is tied to
contributions raised, the activity automatically fails the
a. purpose criterion and all costs of the activity must be charged to program activities.
b. content criterion and all costs of the activity must be charged to fund-raising.
c. purpose criterion and all costs of the activity must be charged to fund-raising.
d. audience criterion and all costs of the activity must be charged to administrative activities.

PROBLEMS
Lamar Company
Lamar Company produces only two products and incurs joint processing costs that total $3,750. Products Alpha and
Beta are produced in the following quantities during each month: 4,500 and 6,000 gallons, respectively. Lamar
Company also runs one ad each month that advertises both products at a cost of $1,500. The selling price per gallon
for the two products are $20 and $17.50, respectively.
1. Refer to Lamar Company. What amount of joint processing costs is allocated to each product
based on gallons produced?
2. Refer to Lamar Company. What amount of advertising cost is allocated to each product based on
sales value?
Moore Company
Moore Company produces three products from the same process and incurs joint processing costs of $3,000.
Disposal
Sales price cost per Further Final sales
per gallon gallon at processing price per
Gallons at split-off split-off costs gallon
M 2,300 $ 4.50  $1.25  $1.00  $ 7.00 
N 1,100  6.00 3.00 2.00 10.00
Q   500 10.00 8.00 2.00 15.00
Disposal costs for the products if they are processed further are:
M, $3.00; N, $5.50; Q, $1.00.
3. Refer to Moore Company. What amount of joint processing cost is allocated to the three products
using sales value at split-off?
4. Refer to Moore Company. What amount of joint processing cost is allocated to the three products
using net realizable value at split-off?
5. Ardmore Company produces two main products jointly, A and B, and C, which is a by-product of
B. A and B are produced from the same raw material. C is manufactured from the residue of the process creating B.
Costs before separation are apportioned between the two main products by the net realizable value method. The net
revenue realized from the sale of C is deducted from the cost of B. Data for April were as follows:
Costs before separation $200,000
Costs after separation:
   A 50,000
   B 32,000
   C 4,000

Production for April, in pounds:

   A 800,000
   B 200,000
   C 20,000

Sales for April:

   A 640,000 pounds @ $.4375
   B 180,000 pounds @ .65
   C  20,000 pounds @ .30
Required: Determine the gross profit for April.

6. Joplin Corporation produces three products from a common manufacturing process. The total
joint cost of producing 2,000 pounds of Product A; 1,000 pounds of Product B; and 1,000 pounds of Product C is
$7,500. Selling price per pound of the three products are $15 for Product A; $10 for Product B; and $5 for Product
C. Joint cost is allocated using the sales value method.
Required:
a. Compute the unit cost of Product A if all three products are main products.

b. Compute the unit cost of Product A if Products A and B are main products and Product C is a
by-product for which the cost reduction method is used.

7. Detroit Manufacturing Company makes three products: A and B are considered main products and
C a by-product.
Production and sales for the year were:
220,000 lbs. of Product A, salable at $6.00
180,000 lbs. of Product B, salable at $3.00
50,000 lbs. of Product C, salable at $.90
Production costs for the year:
Joint costs $276,600
Costs after separation:
Product A 320,000
Product B 190,000
Product C 6,900
Required: Using the by-product revenue as a cost reduction and net realizable value method of assigning joint
costs, compute unit costs (a) if C is a by-product of the process and (b) if C is a by-product of B.

8. Arnold Company processes raw material in Department 1 from which come two main products, A
and B, and a by-product, C. A is further processed in Department 2, B in Department 3, and C in Department 4. The
value of the by-product reduces the cost of the main products, and sales value is used to allocate joint costs.
Dept 1 Dept 2 Dept 3 Dept 4
Cost Incurred: $90,000 $10,000 $8,000 $10,000
Production:
A 10,000 lbs.
 B 20,000 lbs.
C 10,000 lbs.

Selling Price:
A $10/lb.
B $5/lb.
C $2/lb.
Required:

a. Compute unit costs for A and B.

b. Ending inventory consists of 5,000 lbs. of B and 1,000 lbs. of C. What is the value of the
inventory?

c. Recompute a and b allocating cost based on net realizable value.

9. Knight Corporation manufactures three identifiable product lines, Products A, B, and C, from a basic
processing operation. The cost of the basic operation is $320,000 for a yield of 5,000 tons of Product A; 2,000 tons
of Product B; and 1,000 tons of Product C. The basic processing cost is allocated to the product lines in proportion
to the relative weight produced.
Knight Corporation does both the basic processing work and the further refinement of the three product lines. After
the basic operation, the products can be sold at the following prices per metric ton:
Product A—$60 Product B—$53 Product C—$35
Costs to refine each of the three product lines follow:
Product Lines
A B C
Variable cost per metric ton      $8      $7     $4
Total fixed cost $20,000 $16,000 $6,000
The fixed cost of the refining operation will not be incurred if the product line is not refined.
The refined products can be sold at the following prices per metric ton:
Product A—$75 Product B—$65 Product C—$40
Required:
a. Determine the total unit cost of each product line in a refined state.
b. Which of the three product lines, if any, should be refined and which should be sold after the
basic processing operation? Show computations.

10. Bolton Company produced three joint products at a joint cost of $100,000. These products were
processed further and sold as follows:
Product Sales Additional Processing Costs
A $245,000  $200,000 
B 330,000 300,000
C 175,000 100,000
The company has had an opportunity to sell at split-off directly to other processors. If that alternative had been
selected, sales would have been: A, $56,000; B, $28,000; and C, $56,000.
The company expects to operate at the same level of production and sales in the forthcoming year.
Required: Consider all the available information and assume that all costs incurred after split-off are variable.

a. Could the company increase net income by altering its processing decisions? If so, what
would be the expected overall net income?

b. Which products should be processed further and which should be sold at split-off?