CHAPTER 8

Cost Allocation:Joint Products and Byproducts

Joint Cost Terminology

• 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

• Separable Costs – all costs incurred beyond the splitoff point

that are assignable to each of the now-identifiable specific products

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

Joint Cost Terminology

• Main 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

Joint Cost Terminology

• Byproducts – outputs of a joint production process

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

Joint Process Flowchart

Single Production Process

Joint Product #1

Byproduct

Joint Product #2

Steam: An Output with Zero Sales Value

Reasons for Allocating Joint Costs

• Required for GAAP and taxation purposes

• Cost values may be used for evaluation purposes– Cost-based contracting– Insurance settlements– Required by regulators– Litigation

Joint Cost Allocation Methods

• Physical Measures – allocate using tangible attributes of the

products, such as pounds, gallons, barrels, etc.

• Market-Based Measures – allocate using market-derived data (dollars):

– Sales value at splitoff– Net Realizable Value (NRV)– Constant Gross-Margin percentage NRV

Physical-Measure Method

• Allocates 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

Physical-Measure Example

• Consider the following example of two products arising out of one joint process costing $500

• Assumes 1 gallon of Cream is equal to 1 gallon of Skim-milk

JointProduct % Joint Costs

Gallons Total Volume Costs AllocatedCream 25 25% 500$ 125$ Skim-milk 75 75% 500 375 Total 100 100% 500$

Sales Value at Splitoff Method

• Uses the sales value of the entire production of the accounting period to calculate allocation percentage

• Ignores inventories

Sales Value at Splitoff Example

Cream Skim-milk TotalFinal Sales Value of Production

Cream: 25 gals@ $50/gal 1,300$ Skim-milk: 75 gals@ $10/gal 800$ Total 2,100$

Allocation Based on % of Total Sales (rounded) 61.9% 38.1%

Joint Costs ($500) Allocated:Joint Cost X Allocation % 310$ 190$

Net Realizable Value Method

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

• NRV = Final Sales Value – Separable Costs

NRV Example

Cream Skim-milk TotalFinal Sales Value of Production

Cream: 25 gals@ $50/gal 1,300$ Skim-milk: 75 gals@ $10/gal 800$ Total 2,100$

Less: Separable Costs 900 200 1,100

NRV 400 600 1,000

NRV Weighting:Product NRV ÷ Total NRV 40% 60%

Joint Costs 500 500

Joint Costs AllocatedNRV Weighting X Joint Costs 200$ 300$

Constant Gross Margin NRV Method

• Allocates 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

Constant Gross Margin NRV Method Example

Cream Skim-milk TotalFinal Sales Value of Production

Cream: 25 gals@ $50/gal 1,300$ Skim-milk: 75 gals@ $10/gal 800$ Total 2,100$

Less: Separable Costs 1,100

NRV 1,000

Joint Costs 500

Gross Profit 500$

Gross Profit % of Sales Value (rounded) 23.8%

Cream Skim-milk Total

Sales Values 1,300$ 800$ 2,100$

Less Gross Margin @ 23.8%(rounded) 310 190 500

Total Product Costs 990 610 1600

Less Separable Costs 900 200 1100

Joint Costs Allocated 90$ 410$ 500$

Method Selection

• If 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!

Sell-or-Process Further Decisions

• In 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– Separable Costs need to be

evaluated for relevance individually

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

Byproducts

Two methods for accounting for byproducts

• Production 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