AGENDA

Basic Terminologies
AF 3112 Accounting for Joint Product Costs
MANAGEMENT ACCOUNTING 2 Accounting for By-Product Costs
Sell or Process Further Decision
Joint and By-Product Costing

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Joint Product Processes BASIC TERMINOLOGIES

A number of products are produced
from a single raw material input.
Joint Products
l Two or more products produced simultaneously by
Product 1 the same process up to a “split-off” point
Split off Point
l The point in the joint production process when joint
products become separately identifiable
Single Input Product 2
Separable Costs
l All costs incurred beyond the split-off point that are
assignable to each individual products identified at
Product 3 split-off point.
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 BASIC TERMINOLOGIES Joint Product Processes
Main Product Intermediate Final
products products
l The higher value product resulted from a joint production Joint
Costs Separate Final
process compared with other products. Oil
Processing Sale
By Product
l those also produced from joint product process but with less Common Separate
Joint
value Production Processing Costs
Input
Process
The distinction between joint and by-products rests
solely on the relative importance of their sales Separate Final
Gasoline
value. Processing Sale
l Products can change from by-products to joint products when
their relative sales values increases, and vive-versa Split-Off Separate
Point Processing Costs
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Examples of Joint & By Products Joint Costs Allocation Approaches

Industry Joint Products and By-Products

Agriculture & Food Industries:
Flour milling
Extractive Industries:
Copper mining
Chemical Industries:
Soap making
Manufacturing Industries:
Cement
ALLOCATING JOINT COSTS
Patent flour, clear flour,
bran, and wheat germ
Market Based Physical Measure
Copper, gold, silver, and
other metals
Sale Value at Split-off
Soap and glycerine
Net Realizable Value (NRV)
Concrete pipe and aggregate Constant Gross Margin % NRV
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 Physical Measure Method
Physical Measure Method Example
Joint
Allocated on the basis of: Costs Oil 240,000 gallons
l Relative weight, volume or other feasible physical
measure
Common
Joint
No relationship with the revenue producing Input
Production
Process
power of the product
Applicable when: Gasoline 360,000 gallons
l Output product prices are highly volatile
l Market prices are unavailable for joint products such
Split-Off
as on cost-plus contracts Point
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Physical Measure Method Physical Measure Method

Example Example
Joint conversion Product
cost = $225,000 Oil 240,000 gallons Oil Gasoline Total
Output quantities in gallons 240,000 360,000 600,000
Joint
Common Proportionate share:
material
Production ?
cost = Process ?
$275,000
Allocated joint costs:
?
Gasoline 360,000 gallons ?

Split-Off
Point
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 Physical Measure Method Physical Measure Method
Example Example
Product Product
Oil Gasoline Total Oil Gasoline Total
Output quantities in gallons 240,000 360,000 600,000 Output quantities in gallons 240,000 360,000 600,000
Proportionate share: Proportionate share:
240,000 /600,000 40% 240,000 /600,000 40%
360,000 /600,000 60% 360,000 /600,000 60%
Allocated joint costs: Allocated joint costs:
? $500,000 x40% $ 200,000
? $500,000 x60% $ 300,000

$275,000 joint material cost plus

$225,000 joint conversion cost
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Sales Value at Split-off Sales Value at Split-off Example

Joint conversion
Allocate joint costs based on relative total cost = $225,000 Separate
Sales
Oil Value
sales value at split-off point. Processing $500,000
Joint
Common Sales Value Separate
material Processing Costs
Production $320,000
cost = $200,000
Process
$275,000
Sales
Separate Value
Gasoline
Processing $1,200,000

Split-Off Sales Value Separate

$680,000 Processing Costs
Point
$500,000
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 Sales Value at Split-off Example Sales Value at Split-off Example

Product Product
Oil Gasoline Total Oil Gasoline Total
Sales value at split-off $ 320,000 $ 680,000 $ 1,000,000 Sales value at split-off $ 320,000 $ 680,000 $ 1,000,000
Proportionate share: Proportionate share:
? $320,000 / $1,000,000 32%
? $680,000 / $1,000,000 68%
Allocated joint costs: Allocated joint costs:
? ?
? ?

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Sales Value at Split-off Example Net Realizable Value (NRV)

Product
Allocate based on relative NRV
Oil Gasoline Total
Sales value at split-off $ 320,000 $ 680,000 $ 1,000,000
Proportionate share: NRV = Sales – Separable Costs
$320,000 / $1,000,000 32%
$680,000 / $1,000,000 68%
Allocated joint costs: Use when the selling price at split for
$500,000 x 32% $ 160,000
$500,000 x 68% $ 340,000 joint products are not available.

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 Net Realizable Value (NRV) Net Realizable Value (NRV)
Example Example
Product
Joint conversion Sales
cost = $225,000 Separate
Value
Oil Gasoline Total
Oil
Processing $500,000 Sales value $ 500,000 $ 1,200,000 $ 1,700,000
Less additional processing costs ? ? ?
Joint Estimated NRV at split-off point ? ? ?
Common Separate
material Processing Costs
Production Proportionate share:
cost = $200,000
Process ?
$275,000
?
Sales Allocated joint costs:
Separate Value
Gasoline ?
Processing $1,200,000
?
Split-Off Separate
Point Processing Costs Assuming both products will be processed further.
$500,000
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Net Realizable Value (NRV) Net Realizable Value (NRV)

Example Example
Product Product
Oil Gasoline Total Oil Gasoline Total
Sales value $ 500,000 $ 1,200,000 $ 1,700,000 Sales value $ 500,000 $ 1,200,000 $ 1,700,000
Less additional processing costs 200,000 500,000 700,000 Less additional processing costs 200,000 500,000 700,000
Estimated NRV at split-off point $ 300,000 $ 700,000 $ 1,000,000 Estimated NRV at split-off point $ 300,000 $ 700,000 $ 1,000,000
Proportionate share: Proportionate share:
? $300,000 /$1,000,000 30%
? $700,000 /$1,000,000 70%
Allocated joint costs: Allocated joint costs:
? ?
? ?

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 Net Realizable Value (NRV) Constant Gross Margin
Example Percentage NRV
Product Allocate joint cost in a way that overall gross
Oil Gasoline Total margin is identical for individual products.
Sales value $ 500,000 $ 1,200,000 $ 1,700,000
Less additional processing costs 200,000 500,000 700,000
Three steps:
Estimated NRV at split-off point $ 300,000 $ 700,000 $ 1,000,000 l Compute overall gross margin for all joint products.
Proportionate share:
l Gross Margin (%) x Sales Value for each product
$300,000 /$1,000,000 30%
$700,000 /$1,000,000 70% l Sales Value – Gross Margin = Allocated Cost
Allocated joint costs:
$500,000 x30% $ 150,000
A profit allocation method (cross -
$500,000 x70% $ 350,000 subsidization)

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Constant Gross Margin

Percentage NRV Example Why Allocate Joint Costs?
PANEL A Product To get an “A+” in AF3112 J
Oil Gasoline Total
Sales value $ 320,000 $ 1,200,000 $ 1,520,000 Compute inventory cost and COGS
Less Joint Costs (step 3) ? ? 500,000
Less additional processing costs 500,000 500,000
l Important for financial accounting purposes, reports
Gross margin (step 2) ? ? 520,000 to income tax authorities, and internal reporting
Gross margin percentage (step 1) 34.21053 34.21053 34.21053
purposes.
PANEL B
Sales value $ 320,000 $ 1,200,000 $ 1,520,000 To determine cost reimbursement under
Less Joint Costs (step 3) a
Less additional processing costs
$ 210,526 $ 289,474 $ 500,000
500,000 500,000
contracts
Gross margin (step 2)b $ 109,474 $ 410,526 $ 520,000 l It occurs when only a portion of a business’ products
Gross margin percentage (step 1) 34.21053 34.21053 34.21053
b
or services is sold or delivered to a single customer
: $109,474=.3421053x $320,000;$410,526=.3421053x1,200,000
a
: $210,526=$320,000-$109,474; $289,474=$1,200,000-$500,000-$410,526 (i.e. government agency)
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 Choosing Among Joint Cost
Why Allocate Joint Costs?
Allocation Methods
Joint costs are truly
For insurance settlement computation common costs.
For litigation purposes Which joint cost allocation It is impossible to separate
l Joint cost allocation is important in litigation method should we use? the portion of joint costs
attributable to one product
involving one or more joint products We get a different result on a cause and effect
with each method. basis.
For rate regulation
l If one or more of the jointly produced products
or services are subject to price regulation (nat.
gas).

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Choosing Among Joint Cost

Allocation Methods
That makes the choice of methods
somewhat arbitrary.
Regardless of the method we choose, we
really need to be careful using allocated
costs for decision-making purposes.
Choice of Allocation Method
Conceptually, which allocation method is
better?
l First choice: Sales at split-off method if there is
sufficient information
l it measures the value of the joint product
immediately
l It doesn’t anticipate subsequent decisions

l It has meaningful basis

l it is simple

l Second choice: NRV method if there is no enough

info about individual selling prices at split off point
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 Allocating By-Product Costs Accounting for By-Products
Approaches
Joint
Costs Major
Product
ALLOCATING BY-PRODUCT COSTS
Common
Joint Major
Production
Input Product
Process
1. Sales Method 2. Production Method
Relatively low
value or quantity
By-products
Treat NRV of Deduct NRV of when compared to
byproducts as Other byproducts from COST major products
Revenue Split-Off
of main product Point
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Accounting for By-Products Accounting for By-Products

Joint conversion By-Product
cost = $50,000 Sales Accounting Method
Major
Value 2 1
Product
$100,000 Major product revenue $ 170,000 $ 170,000
Other revenue ? ?
Joint Common Sales Total revenue ? ?
Production Major Cost of sales:
Material Value
Process Product Joint production costs ? ?
cost = $70,000
Less by-product NRV ? ?
$50,000
Sales Adjusted cost of sales ? ?
Separate Gross margin ? ?
By-products Processing Value
$1,500

Split-Off Separate Major product revenue = $100,000 + $70,000

Point Processing Costs
$400
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 Accounting for By-Products Accounting for By-Products

By-Product By-Product
Accounting Method Accounting Method
2 1 2 1
Major product revenue $ 170,000 $ 170,000 Major product revenue $ 170,000 $ 170,000
Other revenue 0 1,100 Other revenue 0 1,100
Total revenue 170,000 171,100 Total revenue 170,000 171,100
Cost of sales: Cost of sales:
Joint production costs ? ? Joint production costs 100,000 100,000
Less by-product NRV ? ? Less by-product NRV ? ?
Adjusted cost of sales ? ? Adjusted cost of sales ? ?
Gross margin ? ? Gross margin ? ?

By-product NRV = $1,500 – $400 = $1,100 Joint production costs = $50,000 material + $50,000 conversion

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Accounting for By-Products By-Products: Some Complications

By-Product The preceding example assumes the by-product
Accounting Method has been sold.
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Major product revenue $ 170,000 $ 170,000 If the by-product is unsold . . .
Other revenue 0 1,100 l Using method 1, the $1,100 by-product NRV is
Total revenue 170,000 171,100
placed in a by-product inventory account.
Cost of sales:
Joint production costs 100,000 100,000 l Using method 2, the $1,100 by-product NRV is
Less by-product NRV 1,100 0 deducted from finished goods inventory or
Adjusted cost of sales 98,900 100,000
Gross margin $ 71,100 $ 71,100
work-in-process inventory if unfinished.

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 Irrelevance of Joint Costs for Irrelevance of Joint Costs for
Decision Making Decision Making
Decision to “sell products at split off or process them Data about Sawmill’s joint products includes:
further”
Per Log
Sawmill, Inc. cuts logs from which unfinished Wood
lumber and wood chips are the joint Lumber Chips
products. Sales value at the split-off point $ 140 $ 40
Sales value after further processing 270 50
Unfinished lumber is sold “as is” or Allocated joint product costs 176 24
processed further into finished lumber. Cost of further processing 50 20

Wood chips can also be sold “as is” for

landscaping or processed further into 4 × 8 Question:
composition boards. Should Sawmill sell the products at split-off or
after further processing?
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Irrelevance of Joint Costs for Irrelevance of Joint Costs for

Decision Making Decision Making
Should we include the joint cost in this Analysis of Sell or Process Further
analysis? Per Log
l NO. That is a sunk cost to the sell or process further Wood
Lumber Chips
decision.
Sales value after further processing $ 270 $ 50
Decision Criteria for sell or process further Sales value at the split-off point 140 40
Incremental revenue 130 10
decision:
Cost of further processing 50 20
l Process further if: Profit (loss) from further processing $ 80 $ (10)
l incremental revenue > incremental processing costs

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 Irrelevance of Joint Costs for
Decision Making
Analysis of Sell or Process Further
Per Log End of Topic
Wood
Lumber Chips
Sales value after further processing $ 270 $ 50
Sales value at the split-off point 140 40
Incremental revenue 130 10
Cost of further processing 50 20
Profit (loss) from further processing $ 80 $ (10)

Should we process the lumber

further and sell the wood chips “as is?”
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