1/8/2021 By-product costing and joint product costing — AccountingTools

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Accountants' Guidebook
December 03, 2020 Accounting Controls Guidebook 
Accounting for Casinos & Gaming 
A joint cost is a cost that benefits more than one product, while a by-product Accounting for Inventory
Accounting for Managers
is a product that is a minor result of a production process and which has
Accounting Information Systems
minor sales. Joint costing or by-product costing are used when a business Accounting Procedures Guidebook 
has a production process from which final products are split off during a later Agricultural Accounting 
stage of production. The point at which the business can determine the final Bookkeeping Guidebook
product is called the split-off point. There may even be several split-off Budgeting
CFO Guidebook
points; at each one, another product can be clearly identified, and is
Closing the Books 
physically split away from the production process, possibly to be further Construction Accounting
refined into a finished product. If the company has incurred any Cost Accounting Fundamentals
manufacturing costs prior to the split-off point, it must designate a method for Cost Accounting Textbook
allocating these costs to the final products. If the entity incurs any costs after Credit & Collection Guidebook
Fixed Asset Accounting
the split-off point, the costs are likely associated with a specific product, and
Fraud Examination
so can be more readily assigned to them. GAAP Guidebook
Governmental Accounting 
Besides the split-off point, there may also be one or more by-products. Given Health Care Accounting 
the immateriality of by-product revenues and costs, byproduct accounting Hospitality Accounting 
IFRS Guidebook
tends to be a minor issue.
Lean Accounting Guidebook 
New Controller Guidebook
If a company incurs costs prior to a split-off point, it must allocate them to Nonprofit Accounting 
products, under the dictates of both generally accepted accounting Oil & Gas Accounting 

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1/8/2021 By-product costing and joint product costing — AccountingTools

principles and international financial reporting standards.  If you were not to Payables Management
Payroll Management
allocate these costs to products, then you would have to treat them as period
Public Company Accounting 
costs, and so would charge them to expense in the current period. This may
Real Estate Accounting 
be an incorrect treatment of the cost if the associated products are not sold
until some time in the future, since you would be charging a portion of the Finance Bestsellers
product cost to expense before realizing the offsetting sale transaction. Business Ratios Guidebook
Corporate Cash Management
Corporate Finance
Allocating joint costs does not help management, since the resulting
Cost Management
information is based on essentially arbitrary allocations. Consequently, the
Enterprise Risk Management
best allocation method does not have to be especially accurate, but it should Financial Analysis
be easy to calculate, and be readily defensible if it is reviewed by an auditor. Interpretation of Financials
Investor Relations Guidebook
MBA Guidebook
How to Allocate Joint Costs
Mergers & Acquisitions
Treasurer's Guidebook
There are two common methods for allocating joint costs. One approach
allocates costs based on the sales value of the resulting products, while the Operations Bestsellers
other is based on the estimated final gross margins of the resulting products. Constraint Management
The calculation methods are as follows: Human Resources Guidebook
Inventory Management 
New Manager Guidebook 
• Allocate based on sales value. Add up all production costs through the
Project Management
split-off point, then determine the sales value of all joint products as of Purchasing Guidebook
the same split-off point, and then assign the costs based on the sales
values. If there are any by-products, do not allocate any costs to them; Send us your e-mail address
instead, charge the proceeds from their sale against the cost of goods to receive monthly course
discounts *
sold. This is the simpler of the two methods.

• Allocate based on gross margin. Add up the cost of all processing

costs that each joint product incurs after the split-off point, and subtract
this amount from the total revenue that each product will eventually
SUBMIT
earn. This approach requires additional cost accumulation work, but
may be the only viable alternative if it is not possible to determine the
sale price of each product as of the split-off point (as was the case with
the preceding calculation method).

Price Formulation for Joint Products and By-Products

The costs allocated to joint products and by-products should have no

bearing on the pricing of these products, since the costs have no relationship
to the value of the items sold. Prior to the split-off point, all costs incurred are
sunk costs, and as such have no bearing on any future decisions – such as
the price of a product.

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1/8/2021 By-product costing and joint product costing — AccountingTools

The situation is quite different for any costs incurred from the split-off point
onward. Since these costs can be attributed to specific products, you should
never set a product price to be at or below the total costs incurred after the
split-off point. Otherwise, the company will lose money on every product
sold.

If the floor for a product’s price is only the total costs incurred after the split-
off point, this brings up the odd scenario of potentially charging prices that
are lower than the total cost incurred (including the costs incurred before the
split-off point). Clearly, charging such low prices is not a viable alternative
over the long term, since a company will continually operate at a loss. This
brings up two pricing alternatives:

• Short-term pricing. Over the short term, it may be necessary to allow

extremely low product pricing, even near the total of costs incurred
after the split-off point, if market prices do not allow pricing to be
increased to a long-term sustainable level.

• Long-term pricing. Over the long term, a company must set prices to
achieve revenue levels above its total cost of production, or risk
bankruptcy.

In short, if a company is unable to set individual product prices sufficiently

high to more than offset its production costs, and customers are unwilling to
accept higher prices, then it should cancel production – irrespective of how
costs are allocated to various joint products and by-products.

The key point to remember about the cost allocations associated with joint
products and by-products is that the allocation is simply a formula – it has no
bearing on the value of the product to which it assigns a cost. The only
reason we use these allocations is to achieve valid cost of goods sold
amounts and inventory valuations under the requirements of the various
accounting standards.

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