You are on page 1of 35

# Chapter 16

Cost Allocation:
Joint Products and
Byproducts

## 2009 Foster School of Business Cost Accounting L.DuCharme 1

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

## 2009 Foster School of Business Cost Accounting L.DuCharme 2

Joint-Cost Basics

## Byproduct Splitoff point

Separable costs
2009 Foster School of Business Cost Accounting L.DuCharme 3
Joint-Cost Basics

Coal

## 2009 Foster School of Business Cost Accounting L.DuCharme 4

Joint-Cost Basics

Timber (logs)

## 2009 Foster School of Business Cost Accounting L.DuCharme 5

Joint Products and Byproducts

Main Products
Joint Products Byproducts

High Low

Sales Value

## 2009 Foster School of Business Cost Accounting L.DuCharme 6

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

## 2009 Foster School of Business Cost Accounting L.DuCharme 7

Approaches to Allocating
Joint Costs

## Two basic ways to allocate

joint costs to products are:

Approach 1: Approach 2:
Market based Physical measure

## 2009 Foster School of Business Cost Accounting L.DuCharme 8

Approach 1: Market-based Data
(3 ways)

## 2009 Foster School of Business Cost Accounting L.DuCharme 9

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
2009 Foster School of Business Cost Accounting L.DuCharme 10
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

## 2009 Foster School of Business Cost Accounting L.DuCharme 11

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
2009 Foster School of Business Cost Accounting L.DuCharme 12
Estimated Net Realizable Value
(NRV) Method Example

## What is the estimated net realizable value of each

product at the splitoff point?

## 2009 Foster School of Business Cost Accounting L.DuCharme 13

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

to each product?

## 2009 Foster School of Business Cost Accounting L.DuCharme 14

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

## 2009 Foster School of Business Cost Accounting L.DuCharme 15

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

## 2009 Foster School of Business Cost Accounting L.DuCharme 16

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.
2009 Foster School of Business Cost Accounting L.DuCharme 17
Constant Gross-Margin
Percentage NRV Method

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

## 2009 Foster School of Business Cost Accounting L.DuCharme 18

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

## 2009 Foster School of Business Cost Accounting L.DuCharme 19

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%
2009 Foster School of Business Cost Accounting L.DuCharme 20
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)
2009 Foster School of Business Cost Accounting L.DuCharme 21
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
2009 Foster School of Business Cost Accounting L.DuCharme 22
Constant GM % NRV method

## Something that causes most students to

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

## 2009 Foster School of Business Cost Accounting L.DuCharme 23

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
2009 Foster School of Business Cost Accounting L.DuCharme 24
Choosing a Method

## It measures the value It does not anticipate

of the joint product subsequent management
immediately. decisions.

It uses a
It is simple.
meaningful basis.
2009 Foster School of Business Cost Accounting L.DuCharme 25
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.

## 2009 Foster School of Business Cost Accounting L.DuCharme 26

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?”)

## 2009 Foster School of Business Cost Accounting L.DuCharme 27

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.
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.
2009 Foster School of Business Cost Accounting L.DuCharme 28
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)
2009 Foster School of Business Cost Accounting L.DuCharme 29
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.

## 2009 Foster School of Business Cost Accounting L.DuCharme 30

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.
2009 Foster School of Business Cost Accounting L.DuCharme 31
Accounting for Byproducts

## Byproducts have low sales value.

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

## 2009 Foster School of Business Cost Accounting L.DuCharme 32

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

## 2009 Foster School of Business Cost Accounting L.DuCharme 33

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.

## 2009 Foster School of Business Cost Accounting L.DuCharme 34

End of Chapter 16