Chap 16 - Cost allocating joint products and byproducts

What are joint products?

• One of two or more valuable outputs generated simultaneously from a single raw material and a common production process up to a specific point

• Not separately identifiable until split off point

• Has high sales value

What are byproducts?

Outputs of a joint production process that has a low sales value compared to the sales value of other outputs (e.g. main or joint products)

What is scrap?

• Minimal sales value or a cost to dispose

• Leftover raw materials, trimmings, shavings, or unusable waste generated during the production process that has a relatively low sales value.

What are joint costs

Costs of a single production process that yields multiple products simultaneously

What is the splitoff point

In a joint production process, it is where two or more products become separately identifiable

What are separable costs

Costs incurred beyond the split off point and are assignable to separate products

Why do we allocate joint costs?

• Required for financial statements (to determine inventorial costs and cogs)

• Taxation purposes

• May be used for internal evaluation purposes (division profitability, manager’s performance)

• Cost based contracting

• Customer profitability analysis

• Insurance settlement computations

• Required by price regulators

• Litigation

Cost based contracting

An agreement where a project owner/buyer will reimburse the contractor for all actual documented costs (indirect & direct) plus an additional profit margin

Litigation

Formal process of resolving legal disputes through the public court system

Joint cost allocation methods

1. Physical measures

   1. Allocating using tangible attributes of the products, like pounds, gallons, barrels, etc

2. Sales value at split off

3. Net realizable value (NRV)

4. Constant gross margin percentage NRV

Physical measure method

Allocates joint costs to joint products on the basis of the relative weight, volume, or another physical measure at the split off point of total production of the products

Sales value at split off method

• Uses relative sales value at the split off point of the entire production to calculate allocation percentage

• Ignores inventories

NRV method

Allocates joint costs to joint products on the basis of relative NRV of total production of the joint products

NRV formula is

Final sales value - Separable costs

Constant gross margin NRV method

• Allocates joint costs to joint products in a way that the overall GM % is identical for the individual products

  • GM % being applied identically irrespective of separable costs, results in products with high SC being subsidized/supported by those with lower SC

    • Means those with higher SC are assigned a lower value of joint costs

• Joint costs are calculated as a residual amount

Irrespective

Means ignoring

Which methods are the best?

Split off method → NRV method → Physical measures methods or Constant GM method

Should you Sell or Process Further?

• Joint costs are irrelevant in these decisions

  • Mainly bc JC are sunk

• Separable costs need to be evaluated for relevance

What are the methods for accounting for byproducts?

• Production method

• Sales method

Production method

Recognizes byproduct at the time they are produced (aka at inventory)

Sales method

• Recognizes no byproduct at inventory

  • Bc it is recorded at sale instead

• Recognizes only revenue at the time of sales

• Byproduct costs are not tracked separately