CHAPTER 7

JOINT PRODUCT AND BY PRODUCT COSTING

Aims and objectives

After completing this chapter, you will be able to:

 Define a joint product & by products and give an example
 Differentiate the different method of allocating joint & by product costs
 Explain why joint & byproduct costs should be allocated to individual products
 Identify the split-off point(s) in a joint-cost situation
 Identify the distinction between joint products and By- products

Joint Cost Terminology

 Joint Costs – costs of a single production process that yields multiple products simultaneously.
 Split off Point – the place in a joint production process where two or more products become
separately identifiable.
 Separable Costs – all costs incurred beyond the splitoff point that are assignable to each of the
now-identifiable specific products.
 Categories of Joint Process Outputs:
 Outputs with a positive sales value
 Outputs with a zero sales value
 Product – any output with a positive sales value, or an output that enables a firm to avoid
incurring costs.
 Value can be high or low
 Main Product – output of a joint production process that yields one product with a high sales
value compared to the sales values of the other outputs.
 Joint Products – outputs of a joint production process that yields two or more products with a
high sales value compared to the sales values of any other outputs.
 Byproducts – outputs of a joint production process that have low sales values compare to the
sales values of the other outputs.

Introduction

Joint products: The term joint product refers to a group of products that are produced
simultaneously by a common process. A group of joint products is inseparable until the products
reach a certain point where they are divided or split into separate products. This point is usually
called the split off point.

A joint product cost may be defined as that cost which arises from the common processing or
manufacturing of products produced from a common raw material. Whenever two or more
different products are created from a single cost factor, a joint product cost results. A joint cost is

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incurred prior to the point at which separately identifiable products emerge from the same
process.

Characteristics of joint products

(i) Joint products are produced from the same raw materials in natural proportion.
(ii) They are produced simultaneously by a common process.
(iii) They comparatively of almost equal value.
(iv) They may require further processing after their point of separation.
Examples of entities that manufacture joint products:

Entity Main products By-products

Shell oil Petrol, diesel, jet fuel Asphalt
Flour mill White flour, brown flour Animal feeding stuff
Cheese Fresh cheese, butter Butter milk

Examples of Joint Cost Situations

Reasons for Allocating Joint Costs

 Required for GAAP and taxation purposes: inventory costing and cost of goods sold
computations for financial accounting purposes and reports for income tax authorities.
 Cost values may be used for evaluation purposes: inventory costing and Cost of goods
sold computation for internal reporting purposes. Such reports are used in division

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 profitability analysis when compensation is determined for division managers and
performance measurement of different units and individual worker.
 Cost-based Contracting: cost reimbursement when only a portion of a business’s
products or services is sold or delivered to a single customer (such as government
agency) i.e to specify and resolve contractual interests and obligations.
 Insurance Settlements: estimated casualty loss when damage claims made by business
with joint products, main products or byproducts or byproducts are based on cost
information.
 Required by regulators: for determining and responding to rate regulation when one or
more of the jointly produced products or services are subject to price regulation.
 Litigation: in which products cost number is key inputs. For example, dumping litigation
can involve joint cost allocation when one or more joint products are sold in some
countries.
 For other planning, controlling and decision making activities.

Byproducts: The term by product is generally used to denote one or more products of relatively
small total value that are produced simultaneously with a product of greater total value. The
product with the greater value, commonly called the main product, is usually produced in greater
quantities than the byproducts.

By products and joint products are difficult to cost because a true joint cost is indivisible. For
example, an ore might contain both lead and zinc. In a raw state, these minerals are joint
products. And until they are separated, the cost of finding, mining and processing is a joint cost.
Then, the cost accumulated up to the split off point must be borne by the difference between the
selling price and the cost to complete and sell each mineral after the split off point.

Joint and byproducts usually create cost allocation problem, as their costs can not be allocated
using the cause and effect logic as that of allocating the supporting departments’ cost. There is
no accurate way to determine the amount of joint costs that is caused by any particular joint
product.

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Accounting for joint products
Accounting for joint products means the apportionment of joint costs to each of the joint
products. Such apportionment serves the following objectives:
(a) To determine the cost per unit
(b) To help in venture valuation
(c) To determine the profit or loss on each line of product
(d) To determine the price of each product.

The Various methods of apportionment of joint costs discussed below are based mainly on
individual opinion and tend to produce only approximate result. This is because no perfectly
logical basis exists for the apportionment of joint costs to products and most of the methods are
arbitrary.

There are five basic approaches to allocate joint costs:

1. Allocate based on physical quantities
2. Allocate based on Actual Sales Value at split off point
3. Allocate based on Net Realizable Value (NRV) at split off
4. Allocate based on Net Realizable Value (NRV) less an Average Gross Profit Margin
5. Allocate based on Average unit cost method

Example: Assume that 30,000 and 10,000 units of joint products A and B respectively are
produced at a total joint production cost of $120,000. Product A is sold at $15 and product B for
$10.

Required: allocate the joint cost by using the following methods?

1. Allocate base on physical quantities: This method involves in allocation of joint costs
proportion to a physical measure of joint products at split off point such as the number of
products, gallons, liters, meters etc. It tries to follow the cause and effect or benefit received
logic.

Physical Quantities Allocation

Product A: 30,000 units 30,000/40,000 * $120,000 = $90,000
Product B: 10,000 units 10,000/40,000 * $120,000 = $30,000
Total 40,000 units $120,000

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2. Allocate based on Actual Sales Value at split off point

If the joint products have defined sales values at a point of separation i.e if they are saleable at
point of separation without further processing, then the joint cost can be allocated in proportion
to these values. This approach follows the ability to bear the cost logic.

Allocating joint costs based on sales value at the split off point can be defended on the ground on
the grounds that it produces equal profit percentages at the point of separation, which eliminates
the problems associated with using physical quantities as the allocation base.

Selling Price Allocation

Product A: 30,000 * $15 = $450,000 450,000/550,000 * $120,000 = $98,181.8
Product B: 10,000 * $10 = $100,000 100,000/550,000 * $120,000 = $21,818.2
Total $550,000 $120,000

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.

3. Allocate based on Net Realizable Value (NRV) at split off

NRV refers to a product’s estimated sales value at the split off point. These estimates are
frequently used when an actual sales value at split off point does not exist or cannot be obtained.
A NRV is calculated for each product by subtracting the after split off costs – cost required to
convert the joint product in to marketable condition, from the final sales value.
NRV = Final sales value – After split off cost

Assume the above example except that additional $ 115,600 is incurred to make joint product A
in marketable condition and $84,400 for joint product B. And after the additional process joint
products A and B will be sold at $20 and $12 respectively.
Net Realizable Value Allocation
Product A: $600,000 –115,600 = 484,400 484,400/520,000* $120,000 = $111,784.6
Product B: $120,000 – 84, 400 = 35,600 35,600/520,000 * $120,000 = $8,215.4
Total $520,000 $120,000

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4. Allocate based on Net Realizable Value (NRV) less an Average Gross Profit Margin

This method extends the NRV method by subtracting an average gross profit margin from the net
realizable value to obtain the joint cost allocation. More specifically the calculations are
performed as follows:

Joint cost allocation = Final Sales Value – After split of cost – Average gross profit
Margin
= NRV – (Average GP ratio) (final sales value of each product)
Average GP ratio = (combined final sales value – combined costs)/combined final
sales value
= 720,000 – 120,000 – 200,000 = 400,000/720,000 = 55.56%
Allocation:
Product A: $484,400 - 0.556(600,000) = $151,067
Product B: 35,600 - 0.556 ($120,000) = -$$31,067
Total $120,000
In this method the joint cost is apportioned on the basis of net value of each product. The
net value is calculated on the basis of net value of each product. The net value is calculated
by deducting the following from the sales value.
(a) Estimated profit margin
(b) Selling and distribution costs, if any
(c) After split-off processing costs.
The net value of individual products so obtained is taken as the basis for apportioning joint
costs. This is known as reverse cost method because net values are calculating by working
backward from sales values. This method is particularly used when product are not sold at
their stage at split-off point but require further processing.
Example: Assume in processing a basic raw material, three joint products ‘X’, ‘Y’ and ‘Z’ are
produced. The joint expenses of manufacturing are: materials $10,000, labour $8,000,
overhead $ 9,000 (total $ 27,000). Subsequent /separable/ costs are as follows.
Products
X Y Z
Material……………… .$2,000 ……………$1,600 $1,800
Labour……………… 2,500 …………… 1,400 1,700
Overhead……………… 2,500………… 1,000 1,500
Total 7,000 4,000 5,000
Sales value………... 42,000 20,000 18,000
Estimated profit on sales 50% 50% 33 1/3 %
Required: Show how you would apportion the joint costs of manufacture by
reverse cost method.
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Solution: statement of Apportionment of joint costs

Products
X Y Z
Sales value…… 42,000 20,000 18,000
Less: Estimated profit…… 21,000 10,000 6,000
Estimated total cost 21,000 10,000 12,000
Less: Subsequent cost 7,000 4,000 5,000
Joint cost ($27,000)… 14,000 6,000 7,000

5. Average unit cost method

In this method, the joint cost is apportioned by using the average unit cost which is obtained
by dividing the total joint costs by the total number of units produced of the entire product.
The average cost per unit of each product is the same.

Example: From the following particulars, find out the cost of joint products X, Y and Z under
the average unit cost method

(a) per-separation point costs $30,000

(b) Other production data,
Product Unit produced
X ……………………………………………....1000
Y…………………………………………….....400
Z………………………………………………. 600
Total 2,000 units
Solution:

Average unit cost = Joint Cost

Total No of unit produced
= $30,000
2,000 units
=$ 15 per unit
Statement of Apportionment of Joint Cost
Product Unit Average cost Apportioned Cost
(A) (B) AxB = C
X 1,000 $15 $15,000
Y 400 15 6,000
Z 600 15 9,000
Total 2,000 units $30,000

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Choosing an Allocation Method

Which method of allocating joint costs should be used? The sales value at split-off method is
preferable when selling-price data exist at split-off (even if further processing is done).
Reasons for using the sales value at split-off method include the following:

1. Measurement of the value of the joint products at the split-off point:

 Sales value at split-off is the best measure of the benefits received as a result of
joint processing relative to all other methods of allocating joint costs.
 It is a meaningful basis for allocating joint costs because generating revenues is
the reason why a company incurs joint costs in the first place.
 It is also sometimes possible to vary the physical mix of final output and thereby
produce more or less market value by incurring more joint costs.
 In such cases, there is a clear causal link between total cost and total output
value, thereby further validating the use of the sales value at split-off method.
2. No anticipation of subsequent management decisions:
 The sales value at split - off method does not require information on the
processing steps after split - off if there is further processing.
 In contrast, the NRV and constant gross-margin percentage methods require
information on (a) the specific sequence of further processing decisions, (b) the
separable costs of further processing, and (c) the point at which individual
products will be sold.

3. Availability of a common basis to allocate joint costs to products:

The sales value at split - off method (as well as other market-based methods) has a
common basis to allocate joint costs to products, which is revenue.
In contrast, the physical-measure at split - off method may lack an easily identifiable
common basis to allocate joint costs to individual products.
4. Simplicity: The sales value at split-off method is simple. In contrast, the NRV and constant
gross-margin percentage NRV methods can be complex for processing operations having
multiple products and multiple split-off points. This complexity increases when management
makes frequent changes in the specific sequence of post-split-off processing decisions or in
the point at which individual products are sold.

Note: Despite this, some firms choose not to allocate joint costs at all.

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Accounting for Byproducts

Joint production processes may yield not only joint products and main products but also
byproducts. Although byproducts have relatively low total sales values, the presence of
byproducts in a joint production process can affect the allocation of joint costs.

We present two byproduct accounting methods: the production method and the sales method.
The production method recognizes byproducts in the financial statements at the time production
is completed. The sales method delays recognition of byproducts until the time of sale.

Example: The Westlake Corporation processes timber into fine-grade lumber and wood chips
that are used as mulch in gardens and lawns. Information about these products follows:
Fine-Grade lumber (the main product)—sells for $6 per board foot (b.f.)
Wood chips (the byproduct)—sells for $1 per cubic foot (c.f.)
Data for July 2012 are as follows:

Beginning Inventory Production Sales Ending Inventory

Fine-Grade lumber (b.f.) 0 50,000 40,000 10,000
Wood chips (c.f.) 0 4,000 1,200 2,800
Joint manufacturing costs for these products in July 2012 are $250,000, comprising $150,000 for
direct materials and $100,000 for conversion costs. Both products are sold at the splitoff point
without further processing.
Required: Allocate byproduct cost to the byproducts by using the two methods?

Solution:
Income Statements of Westlake Corporation for July 2012 Using the Production and Sales
Methods for Byproduct Accounting

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Production Method: Byproducts Recognized at Time Production Is Completed
This method recognizes the byproduct in the financial statements—the 4,000 cubic feet of wood
chips—in the month it is produced, July 2012. The NRV from the byproduct produced is offset
against the costs of the main product. The following journal entries illustrate the production
method:
1. Work in Process 150,000
Accounts Payable 150,000
To record direct materials purchased and used in production during July.
2. Work in Process 100,000
Various accounts such as Wages Payable and Accumulated Depreciation 100,000
To record conversion costs in the production process during July; examples include
energy, manufacturing supplies, all manufacturing labor, and plant depreciation.
3. Byproduct Inventory—Wood Chips (4,000 c.f. * $1 per c.f.) 4,000
Finished Goods—Fine-Grade Lumber ($250,000 - $4,000) 246,000
Work in Process ($150,000 + $100,000) 250,000
To record cost of goods completed during July.

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4. a. Cost of Goods Sold [(40,000 b.f. , 50,000 b.f.) * $246,000] 196,800
Finished Goods—Fine-Grade Lumber 196,800
To record the cost of the main product sold during July
b. Cash or Accounts Receivable (40,000 b.f. * $6 per b.f.) 240,000
Revenues—Fine-Grade Lumber 240,000
To record the sales of the main product during July
5. Cash or Accounts Receivable (1,200 c.f. * $1 per c.f.) 1,200
Byproduct Inventory—Wood Chips 1,200
To record the sales of the byproduct during July

Sales Method: Byproducts Recognized at Time of Sale

This method makes no journal entries for byproducts until they are sold. Revenues of the
byproduct are reported as a revenue item in the income statement at the time of sale. These
revenues are either grouped with other sales, included as other income, or are deducted from cost
of goods sold. In the Westlake Corporation example, byproduct revenues in July 2012 are $1,200
(1,200 cubic feet X $1 per cubic foot) because only 1,200 cubic feet of wood chips are sold in
July (of the 4,000 cubic feet produced). The journal entries are as follows:
1 and 2 Same as for the production method.
Work in Process 150,000
Accounts Payable 150,000
Work in Process 100,000
Various accounts such as Wages Payable and Accumulated Depreciation 100,000
3. Finished Goods—Fine-Grade Lumber 250,000
Work in Process 250,000
To record cost of main product completed during July
4a. Cost of Goods Sold [(40,000 b.f. / 50,000 b.f.) * $250,000] 200,000
Finished Goods—Fine-Grade Lumber 200,000
To record the cost of the main product sold during July.
4b. same as for the production method
Cash or Accounts Receivable (40,000 b.f. * $6 per b.f.) 240,000
Revenues—Fine-Grade Lumber 240,000
5. Cash or Accounts Receivable 1,200
Revenues—Wood Chips 1,200
To record the sales of the byproduct during July

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Other Approaches to Allocate Byproduct Costs
There are four commonly used methods:
Method 1 Revenue from sales of the byproduct is listed on the income statement as
1. Other income
2. Additional sales revenue
3. A deduction from the CGS of the main product
4. A deduction from the total manufacturing cost of the main product
Method 2 Revenue from sales of the byproduct less the cost of placing the by product on the
market and less any additional processing cost of the byproduct is shown on the income
statement in a manner similar to that indicated in method 1.

Method 3 Replacement method: This method applied by entities whose by products are used
within the plant, thereby avoiding purchasing other materials and supplies from outside
suppliers. The production cost of the main product is credited or such materials and the offsetting
debit is to the department that uses the by product. The cost assigned to the byproduct is the
purchase or replacement cost existing in the market.

Method 4 The market value (reversal cost) method: This method is similar to the last technique
illustrated in method 1. However, it reduces the manufacturing cost of the main product not by
the actual revenue received but by an estimate of the byproduct’s value at the time of recovery.
This estimate must be made prior to split off from the main product.

Example: To examine how the revenue from sales of a byproduct is to be listed on the income
statement under the different alternatives of method 1, look the following

i) Sales (main product, 10,000 units at $2) ……………..………………………. 20,000

Cost of Goods Sold:
Beg inventory (1,000 units ai$1.50) …………………...………..1,500
Total production cost (11,000 units at$1.50) ………..……….. 16,500
Cost of Goods Available for Sale …………………..…….…. 18,000
Ending inventory (2,000 units at $1.50) ………………......….... 3,000 15,000
Gross profit ……….…………………………………………….……… 5,000
Operating Exp …………………………………………………………… (2,000)
Operating income …………………………..……………………………… 3,000
Other income: sale of byproducts ……………………………………………. 1,500
Income before tax …………………………….……………….……………. 4,500

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 ii) Sales (main product, 10,000 units at $2 and byproducts) …………….……….. 21,500
Cost of Goods Sold:
Beg inventory (1,000 units ai$1.50) ………………….……. 1,500
Total production cost (11,000 units at$1.50) ……….…….. 16,500
Cost of Goods Available for Sale …………………..…….. 18,000
Ending inventory (2,000 units at $1.50) ………………..….. 3,000 15,000
Gross profit ……….………………………………………………………,.. 6,500
Operating Exp ……………………………………………………………… 2,000
Operating income …………………………………………………………... 4,500

iii. Sales (main product, 10,000 units at $2) ……………………………………….…... 20,000

Cost of Goods Sold:
Beg inventory (1,000 units ai$1.50) ………………….………. 1,500
Total production cost (11,000 units at$1.50) ……….……….. 16,500
Cost of Goods Available for Sale …………………..…….…. 18,000
Ending inventory (2,000 units at $1.50) ………………..…… 3,000 15,000
Less: revenue from byproduct ………………………………………….. (1,500) 13,500
Gross profit ……….…………………………………………………………… 6,500
Operating Exp ………………………………………………………………… 2,000
Operating income …………………………………………………………….. 4,500

iv.) Sales (main product, 10,000 units at $2) ……………………………………. 20,000

Cost of Goods Sold:
Beg inventory (1,000 units ai$1.50) ………………….….…. 1,500
Total production cost (11,000 units at$1.50) ……….…….. 16,500
Less: revenue from sale of byproducts ……………..……… (1,500)
Cost of Goods Available for Sale …………………..…….. 16,500
Ending inventory (2,000 units at $1.50) ………………..… 3,000 13,500
Gross profit ……….………………………………………………………, 6,500
Operating Exp ………………………………………………………….…. 2,000
Operating income …………………………………………………………. 4,500

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Distinction between Joint products and By Products

There are no hard and fast rules to distinguish between joint products and by-products. A
product may be treated as a by-product in one business and the same product may be treated as a
joint product in another business. However, the following factors should be considered to
determine if a product is a joint product or a by-product.

a) Relative sales value: If the sales values of the entire product are more or less equal, they are
treated as joint products. If however, there is wide difference in the relative sales values of
products, the product with the greater sales value is treated as the main product and the
products of lower value are treated as by product.
b) Objective of manufacture: If the objective of manufacturing is product A, the unwanted
product B and C be treated as by-product.
c) Policy of management: The management may decide to treat a particular product as the
main product and the other products as by products.

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