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Chapter 16

Cost Allocation:
Joint Products and
Byproducts

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Joint Costing Overview
•Terminology
•Joint cost examples
•Joint versus Byproducts
•Ways to allocate:
Sales-value at Splitoff
NRV
Constant Gross Margin %
Physical Measure
•Accounting for Byproducts

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Joint-Cost Basics

Joint costs Joint products

Byproduct Splitoff point

Separable costs
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Joint-Cost Basics

Coal

Gas Benzyl Tar

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Joint-Cost Basics

Timber (logs)

2x4s 1x8 clear Bark

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Joint Products and Byproducts

Main Products
Joint Products Byproducts

High Low

Sales Value

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Why Allocate Joint Costs?

• to compute inventory cost and cost of goods sold


• to determine cost reimbursement under contracts
• for insurance settlement computations
• for rate regulation
• for litigation purposes

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Approaches to Allocating
Joint Costs

Two basic ways to allocate


joint costs to products are:

Approach 1: Approach 2:
Market based Physical measure

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Approach 1: Market-based Data
(3 ways)

Sales value at splitoff method

Estimated net realizable value (NRV) method

Constant gross-margin percentage NRV method

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Allocating Joint Costs Example

10,000 units of A at a
selling price of $10 = $100,000
Joint processing
cost is $200,000
10,500 units of B at a
selling price of $30 = $315,000

11,500 units of C at a
selling price of $20 = $230,00 Splitoff point
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Allocating Joint Costs Example
(Sales-Value-at-Splitoff method)

A B C Total
Sales Value $100,000 $315,000 $230,000 $645,000
Allocation of
Joint Cost:
100 ÷ 645 31,008
315 ÷ 645 97,674
230 ÷ 645 71,318
200,000
Gross margin $ 68,992 $217,326 $158,682 $445,000

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Estimated Net Realizable Value
(NRV) Method Example

Assume that the Company can process


products A, B, and, C further into A1, B1, and C1.
The new sales values after further processing are:

A1: B1: C1:


10,000 × $12.00 10,500 × $33.00 11,500 × $21.00
= $120,000 = $346,500 = $241,500
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Estimated Net Realizable Value
(NRV) Method Example

Additional processing (separable) costs are as follows:

A1: $35,000 B1: $46,500 C1: $51,500

What is the estimated net realizable value of each


product at the splitoff point?

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Estimated Net Realizable Value
(NRV) Method Example

Product A1: $120,000 – $35,000 = $ 85,000


Product B1: $346,500 – $46,500 = $300,000
Product C1: $241,500 – $51,500 = $190,000

How much of the joint cost is allocated


to each product?

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Estimated Net Realizable Value
(NRV) Method Example

Joint cost allocated To A1:


85 ÷ 575 × $200,000 = $ 29,565
To B1:
300 ÷ 575 × $200,000 = $104,348
To C1:
190 ÷ 575 × $200,000 = $ 66,087

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Estimated Net Realizable Value
(NRV) Method Example

Allocated Separable Inventory


joint costs costs costs
A1 $ 29,565 $ 35,000 $ 64,565
B1 104,348 46,500 150,848
C1 66,087 51,500 117,587
Total $200,000 $133,000 $333,000

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Constant Gross-Margin
Percentage NRV Method
This method entails three steps:
Step 1:
Compute the overall gross-margin percentage.
Step 2:
Use the overall gross-margin percentage
and deduct the gross margin from the
final sales values to obtain the total
costs that each product should bear.
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Constant Gross-Margin
Percentage NRV Method

Step 3:
Deduct the expected separable costs from the
total costs to obtain the joint-cost allocation.

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Constant Gross-Margin
Percentage NRV Method

What is the expected final sales value of total


production during the accounting period?
Product A1: $120,000
Product B1: 346,500
Product C1: 241,500
Total $708,000

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Constant Gross-Margin
Percentage NRV Method

Step 1:
Compute the overall gross-margin percentage.
Expected final sales value $708,000
Deduct joint and separable costs 333,000
Gross margin $375,000
Gross margin percentage:
$375,000 ÷ $708,000 = 52.966%
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Constant Gross-Margin
Percentage NRV Method
Step 2:
Deduct the gross margin.
Sales Gross Cost of
Value Margin Goods sold
Product A1: $120,000 $ 63,559 $ 56,441
Product B1: 346,500 183,527 162,973
Product C1: 241,500 127,913 113,587
Total $708,000 $375,000 $333,000
($1 rounding)
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Constant Gross-Margin
Percentage NRV Method
Step 3:
Deduct separable costs.
Cost of Separable Joint costs
goods sold costs allocated
Product A1: $ 56,441 $ 35,000 $ 21,441
Product B1: 162,973 46,500 116,473
Product C1: 113,587 51,500 62,087
Total $333,000 $133,000 $200,000
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Constant GM % NRV method

Something that causes most students to


“pause” can happen when using this method
to allocate joint costs, what is it????

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Approach 2: Physical
Measure Method Example
$200,000 joint cost

20,000 48,000 12,000


pounds A pounds B pounds C

Product A Product B Product C


$50,000 $120,000 $30,000
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Choosing a Method

Why is the sales value at splitoff method widely used?

It measures the value It does not anticipate


of the joint product subsequent management
immediately. decisions.

It uses a
It is simple.
meaningful basis.
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Choosing a Method

The purpose of the joint-cost allocation is


important in choosing the allocation method.

The physical-measure method is a more


appropriate method to use in rate regulation.

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Avoiding Joint Cost Allocation

Some companies refrain from allocating joint


costs and instead carry their inventories
at estimated net realizable value.
(This is the “ceiling” of LCM rule.
What is the “floor?”)

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Irrelevance of Joint Costs
for Decision Making
Assume that products A, B, and C can be sold
at the splitoff point or processed further
into A1, B1, and C1.
Selling Selling Additional
Units price (1) price (2) costs
10,000 A: $10 A1: $12 $35,000
10,500 B: $30 B1: $33 $46,500
11,500 C: $20 C1: $21 $51,500
(1) value at splitoff; (2) value after processing further.
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Irrelevance of Joint Costs
for Decision Making
Should A, B, or C be sold at the splitoff
point or processed further?
Product A: Incremental revenue $20,000
– Incremental cost $35,000 = ($15,000)
Product B: Incremental revenue $31,500
– Incremental cost $46,500 = ($15,000)
Product C: Incremental revenue $11,500
– Incremental cost $51,500 = ($40,000)
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Accounting for Byproducts

Method A:
The production method recognizes byproducts
at the time their production is completed.
Method B:
The sale method delays recognition of
byproducts until the time of their sale.

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Accounting for Byproducts

Neither approach is conceptually correct.


Both technically violate GAAP.
Method A:
Recognizes byproducts revenue
at the time their production is completed.
Method B:
Does not recognize byproducts in inventory.
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Accounting for Byproducts

Byproducts have low sales value.


Cost-benefit analysis often times leads to the
use of the most expedient method.

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Accounting for Byproducts

An alternative approach that would follow


GAAP would be to treat byproducts as if
they were joint products (i.e., use the same
joint cost allocation method for all products.

This is not common practice, why?

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Accounting for Byproducts

Byproduct revenues appear in the income


statement as either:
 Cost reduction for the main product, or
 Separate item of revenue or other income.

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End of Chapter 16

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