Ch 15 - Joint products and byproducts

Joint product

two or more products after the splitoff point with a high sales value

Main product

Output of joint production process that yields one product with a high sales value compared to the other values of other outputs

Byproduct

Product after the splitoff point with a low sales value

Scrap product

Product after the splitoff point with minimal to no sales value

Toxic waste

Product after the splitoff point with negative sales value

• Disposal costs should be added to joint production costs prior to allocating that cost to main, joint or byproducts

Joint costs

Costs of a single production process that yields multiple products simultaneously

Splitoff point

The place in a joint production process where two or more products become separately identifiable

• The products could have a positive sales value or zero sales value

Separable costs

Costs incurred beyond the splitoff point that are assigned to one or more individual products

Product

Any output with a positive sales value, or an output used internally that enables a firm to avoid incurring costs

(Sales value can be high or low)

Reasons for allocating joint costs

1. Required for GAAP and taxation purposes (COGS for financial accounting and tax reporting)

2. Internal analysis of divisional profitability

3. Cost-based contracting

4. Insurance settlements

5. Required rate and price regulations

6. Litigation

Joint cost allocation methods

1. Physical-measure-based data (using tangible attributes of the products such as weight or volume) → may not be fair because weight does not always mean it costs more

2. Sales value at split-off

3. Estimated NRV

4. Constant GM % NRV

The last 3 are on market-based data (dollars) → market value is better, more reliable

Physical measure method

Allocated joint costs on the basis of their relative proportions at the splitoff point.

• Using common physical measure such as weight or volume

Shortcomings:

• Physical allocation measure has no relationship to the revenue-producing power of the individual products

• Problematic if no common physical measure is available

Sales value at splitoff method

Allocation is based on the relative sales value at the splitoff point

• Costs are allocated to products in proportion to their revenue-generating power

• Consistent with the benefits-recieved criterion of cost allocation

Ignore inventories: joint costs are allocated to the products based on production in the current period

Net realizable value (NRV) method

Allocation based on the relative estimated net realizable value (NRV) of total production of the joint products

• The expected sales value less any separable production and marketing costs

• Useful method when selling prices of one or more products at splitoff do not exist

NRV = Final sales value - Separable costs

Constant Gross margin % of NRV method

Allocates joint costs in a way that the overall gross-margin percentage is identical for the individual products

• Joint costs are calculated as a residual amount

Method selection

Sales value at splitoff is the preferred method

• Consistent with benefits-received criterion

• Does not presuppose any further management actions (i.e., processing further)

• The denominator used (dollars) is meaningful and consistent (may not be available under other methods)

• Simple to calculate

• BUT…not always feasible – may not be able to sell the product until it has been processed further

NRV is the predominant choice

• Can be used for products that have no market value at the splitoff point

Physical measures are usually used in rate-regulated settings

Challenges for management accountants

• Market-based joint cost allocation methods (i.e., SV at Splitoff, NRV, Constant GM % of NRV) result in positive operating incomes for all products

• Allocating joint costs using physical measures can result in one or more joint products having negative operating income

Managers may be reluctant to be responsible for products with negative margins (Dont want to look bad)

Byproduct methods

Production method

Sales method

Production method

• Recognizes byproduct inventory as it is produced

• Recorded as inventory at its future estimating selling price, or at selling price - normal profit margin

• Sales value of the byproduct is used to offset the cost of the main (or joint) products

• Records the value of a product that is not yet sold, but it doesnt matter because it has a low sales value

Sales method

• Delays recognition of byproducts until they are sold

• Byproduct inventory is not recognized

• Revenue is recorded at the time of sale

Sell now or process further decisions

• Joint costs are irrelevant in these decisions, they are sunk costs

• Joint product costs have been incurred and a prospective decision must be made: to sell immediately or process further and sell later

• Separable costs need to be evaluated for relevance individually