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Cost Allocation:Joint Products and Byproducts

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Joint Cost TerminologyJoint 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

Separable costs—all costs incurred beyond the splitoff point that are assignable to each of the now-identifiable specific products

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Joint Cost Terminology Categories of joint process outputs:

1. Outputs with a positive sales value2. 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

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Joint Cost TerminologyMain 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

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Joint Cost TerminologyByproducts—outputs of a joint production

process that have low sales values compare to the sales values of the other outputs

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Examples of Joint Cost Situations

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Joint Process Overview

Single Production Process

Joint Product #1

Byproduct

Joint Product #2

Steam: An Output with Zero Sales Value

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Reasons for Allocating Joint CostsRequired for GAAP and taxation purposesComputation of inventoriable costs and cost

of goods sold for financial accounting and tax reporting

Internal analysis of divisional profitabilityCost-based contractingInsurance settlementsRequired for rate and price regulationsLitigation

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Joint Cost Allocation Methods Market-based—allocate using market-

derived data (dollars):1. Sales value at splitoff2. Net realizable value (NRV)3. Constant gross-margin percentage NRV

Physical measures—allocate using tangible attributes of the products, such as pounds, gallons, barrels, and so on

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Sales Value at Splitoff MethodUses the sales value of the entire production

of the accounting period to calculate allocation percentage

Ignores inventories

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Joint Cost Illustration Data

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Joint Cost Illustration Overview

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Sales Value at Splitoff Illustration

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Net Realizable Value MethodAllocates joint costs to joint products on the

basis of relative NRV of total production of the joint products

NRV = Final Sales Value – Separable Costs

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Net Realizable Value Method Overview

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Net Realizable Value Method Illustrated

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Net Realizable Value Method Illustrated

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Constant Gross Margin NRV MethodAllocates joint costs to joint products in a way

that the overall gross-margin percentage is identical for the individual products.

Joint costs are calculated as a residual amount.

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Constant Gross Margin NRV Illustrated

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Physical-Measure MethodAllocates joint costs to joint products on the

basis of the relative weight, volume, or other physical measure at the splitoff point of total production of the products

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Physical Measures Illustration

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Method SelectionIf selling price at splitoff is available, use

the sales value at splitoff method.If selling price at splitoff is not available,

use the NRV method.If simplicity is the primary consideration,

physical-measures method or the constant gross-margin method could be used.

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

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Sell-or-Process Further DecisionsIn sell-or-process further decisions, joint

costs are irrelevant. Joint products have been produced, and a prospective decision must be made: to sell immediately or process further and sell later.

Joint costs are sunk costs.Don’t assume all separable costs in joint-cost

allocations are always incremental costs.Some separable costs may be fixed costs.Separable costs need to be evaluated for

relevance individually .

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Sell-or-Process Further Flowchart

Single Production Process

Joint Product #1

Joint Product #2

Further Processing Dept 1

Further Processing Dept 2

Final Product

#1

Final Product

#2

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ByproductsTwo methods for accounting for byproductsProduction method—recognizes byproduct

inventory as it is created, and sales and costs at the time of sale

Sales method—recognizes no byproduct inventory, and recognizes only sales at the time of sales: byproduct costs are not tracked separately

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Byproducts Illustration Overview

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Comparative Income Statements for Accounting for Byproducts

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