5 Joint and By product costing v1 w5 PDF

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AGENDA Basic Terminologies Accounting for Joint Product Costs Accounting for By-Product Costs Sell or Process Further Decision

AF 3112 MANAGEMENT ACCOUNTING 2 Joint and By-Product Costing

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Joint Product Processes

BASIC TERMINOLOGIES

A number of products are produced from a single raw material input.

Joint Products 

Product 1

Two or more products produced simultaneously by the same process up to a “split-off” point

Split off Point 

Single Input

Product 2

The point in the joint production process when joint products become separately identifiable

Separable Costs 

Product 3 3

All costs incurred beyond the split-off point that are assignable to each individual products identified at split-off point. 4

Joint Product Processes

BASIC TERMINOLOGIES Main Product 

Joint Costs

The higher value product resulted from a joint production process compared with other products.

Intermediate products Oil

Final products Separate Processing

Final Sale

By Product 

those also produced from joint product process but with less value

Joint Input

Common Production Process

The distinction between joint and by-products rests solely on the relative importance of their sales value. 

Products can change from by-products to joint products when their relative sales values increases, and vive-versa

Separate Processing Costs

Gasoline

Split-Off Point

Separate Processing

Final Sale

Separate Processing Costs

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Joint Costs Allocation Approaches

Examples of Joint & By Products

ALLOCATING JOINT COSTS Market Based

Physical Measure

Sale Value at Split-off Net Realizable Value (NRV) Constant Gross Margin % NRV 7

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Physical Measure Method Example

Physical Measure Method

Joint Costs

Allocated on the basis of: 

Relative weight, volume or other feasible physical measure Joint Input

No relationship with the revenue producing power of the product Applicable when:

240,000 gallons

Oil

Common Production Process

Gasoline

Output product prices are highly volatile  Market prices are unavailable for joint products such as on cost-plus contracts

360,000 gallons



Split-Off Point 9

Physical Measure Method Example Joint conversion cost = $225,000 Joint material cost = $275,000

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Physical Measure Method Example Product

Oil

240,000 gallons Output quantities in gallons Proportionate share:

Common Production Process

Oil

Gasoline

Total

240,000

360,000

600,000

? ? Allocated joint costs: Gasoline

?

360,000 gallons

?

Split-Off Point 11

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Physical Measure Method Example

Physical Measure Method Example

Product Output quantities in gallons Proportionate share: 240,000 /600,000 360,000 /600,000

Product

Oil

Gasoline

Total

240,000

360,000

600,000

Output quantities in gallons Proportionate share: 240,000 /600,000 360,000 /600,000

40% 60%

Allocated joint costs:

Allocated joint costs: $500,000 x40% $500,000 x60%

? ?

Oil

Gasoline

Total

240,000

360,000

600,000

40% 60% $ 200,000 $ 300,000

$275,000 joint material cost plus $225,000 joint conversion cost 13

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Sales Value at Split-off Example

Sales Value at Split-off

Joint conversion cost = $225,000

Allocate joint costs based on relative total sales value at split-off point.

Joint material cost = $275,000

Common Production Process

Oil

Sales Value $320,000

Gasoline

Split-Off Point 15

Sales Value $680,000

Sales Value $500,000

Separate Processing Separate Processing Costs $200,000

Separate Processing

Sales Value $1,200,000

Separate Processing Costs $500,000 16

Sales Value at Split-off Example

Sales Value at Split-off Example

Product Oil Sales value at split-off Proportionate share:

Product

Gasoline

Total

Oil

$ 320,000 $ 680,000 $ 1,000,000 ? ?

Allocated joint costs:

Sales value at split-off Proportionate share: $320,000 / $1,000,000 $680,000 / $1,000,000

Gasoline

Total

$ 320,000 $ 680,000 $ 1,000,000 32% 68%

Allocated joint costs: ?

? ?

?

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Sales Value at Split-off Example

Net Realizable Value (NRV)

Product Oil Sales value at split-off Proportionate share: $320,000 / $1,000,000 $680,000 / $1,000,000 Allocated joint costs: $500,000 x 32% $500,000 x 68%

Gasoline

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Allocate based on relative NRV

Total

$ 320,000 $ 680,000 $ 1,000,000

NRV = Sales – Separable Costs

32% 68%

Use when the selling price at split for joint products are not available.

$ 160,000 $ 340,000

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Net Realizable Value (NRV) Example Joint conversion cost = $225,000 Joint material cost = $275,000

Net Realizable Value (NRV) Example Product

Sales Value $500,000

Separate Processing

Oil

Separate Processing Costs $200,000

Common Production Process

Oil Sales value Less additional processing costs Estimated NRV at split-off point Proportionate share:

Gasoline

Total

$ 500,000 $ 1,200,000 $ 1,700,000 ? ? ? ? ? ? ? ?

Gasoline

Separate Processing

Sales Value $1,200,000

Separate Processing Costs $500,000

Split-Off Point

Allocated joint costs: ? ?

Assuming both products will be processed further. 21

Net Realizable Value (NRV) Example

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Net Realizable Value (NRV) Example Product

Product Oil Sales value Less additional processing costs Estimated NRV at split-off point Proportionate share:

Gasoline

Oil

Total

$ 500,000 $ 1,200,000 $ 1,700,000 200,000 500,000 700,000 $ 300,000 $ 700,000 $ 1,000,000 ? ?

Gasoline

Total

Sales value $ 500,000 $ 1,200,000 $ 1,700,000 Less additional processing costs 200,000 500,000 700,000 Estimated NRV at split-off point $ 300,000 $ 700,000 $ 1,000,000 Proportionate share: $300,000 /$1,000,000 30% $700,000 /$1,000,000 70% Allocated joint costs:

Allocated joint costs:

?

?

?

?

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Net Realizable Value (NRV) Example

Constant Gross Margin Percentage NRV

Product Oil

Gasoline

Total

Sales value $ 500,000 $ 1,200,000 $ 1,700,000 Less additional processing costs 200,000 500,000 700,000 Estimated NRV at split-off point $ 300,000 $ 700,000 $ 1,000,000 Proportionate share: $300,000 /$1,000,000 30% $700,000 /$1,000,000 70% Allocated joint costs: $500,000 x30% $500,000 x70%

Allocate joint cost in a way that overall gross margin is identical for individual products. Three steps: Compute overall gross margin for all joint products. Gross Margin (%) x Sales Value for each product  Sales Value – Gross Margin = Allocated Cost  

A profit allocation method (cross subsidization)

$ 150,000 $ 350,000

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Constant Gross Margin Percentage NRV Example PANEL A

Why Allocate Joint Costs? To get an “A+” in AF3112 ☺ Compute inventory cost and COGS

Product Oil

Gasoline

Total

Sales value $ 320,000 $ 1,200,000 $ 1,520,000 Less Joint Costs (step 3) ? ? 500,000 Less additional processing costs 500,000 500,000 Gross margin (step 2) ? ? 520,000 Gross margin percentage (step 1) 34.21053 34.21053 34.21053 PANEL B Sales value Less Joint Costs (step 3) a Less additional processing costs



To determine cost reimbursement under contracts

$ 320,000 $ 1,200,000 $ 1,520,000 $ 210,526 $

289,474 $ 500,000

500,000 500,000

$ 109,474 $ 410,526 $ 520,000 Gross margin (step 2)b Gross margin percentage (step 1) 34.21053 34.21053 34.21053 b

: $109,474=.3421053x $320,000;$410,526=.3421053x1,200,000

a

: $210,526=$320,000-$109,474; $289,474=$1,200,000-$500,000-$410,526

Important for financial accounting purposes, reports to income tax authorities, and internal reporting purposes.



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It occurs when only a portion of a business’ products or services is sold or delivered to a single customer (i.e. government agency) 28

Choosing Among Joint Cost Allocation Methods

Why Allocate Joint Costs?

Joint costs are truly common costs.

For insurance settlement computation For litigation purposes 

Which joint cost allocation method should we use?

Joint cost allocation is important in litigation involving one or more joint products

We get a different result with each method.

For rate regulation 

It is impossible to separate the portion of joint costs attributable to one product on a cause and effect basis.

If one or more of the jointly produced products or services are subject to price regulation (nat. gas).

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Choosing Among Joint Cost Allocation Methods

Choice of Allocation Method Conceptually, which allocation method is better?

That makes the choice of methods somewhat arbitrary.



Regardless of the method we choose, we really need to be careful using allocated costs for decision-making purposes.

First choice: Sales at split-off method if there is sufficient information it measures the value of the joint product immediately  It doesn’t anticipate subsequent decisions  It has meaningful basis  it is simple 



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Second choice: NRV method if there is no enough info about individual selling prices at split off point 32

Allocating By-Product Costs Approaches

Accounting for By-Products Joint Costs

ALLOCATING BY-PRODUCT COSTS 1. Sales Method

2. Production Method

Treat NRV of byproducts as Other Revenue

Joint Input

Common Production Process

Major Product

Major Product

Relatively low value or quantity when compared to major products

By-products

Deduct NRV of byproducts from COST of main product

Split-Off Point 33

Accounting for By-Products Joint conversion cost = $50,000

Joint Material cost = $50,000

Common Production Process

Split-Off Point

Accounting for By-Products

Major Product

Sales Value $100,000

Major Product

Sales Value $70,000

By-products

Separate Processing

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Sales Value $1,500

Separate Processing Costs $400

Major product revenue Other revenue Total revenue Cost of sales: Joint production costs Less by-product NRV Adjusted cost of sales Gross margin

By-Product Accounting Method 2 1 $ 170,000 $ 170,000 ? ? ? ? ? ? ? ?

? ? ? ?

Major product revenue = $100,000 + $70,000 35

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Accounting for By-Products

Major product revenue Other revenue Total revenue Cost of sales: Joint production costs Less by-product NRV Adjusted cost of sales Gross margin

Accounting for By-Products

By-Product Accounting Method 2 1 $ 170,000 $ 170,000 0 1,100 170,000 171,100 ? ? ? ?

Major product revenue Other revenue Total revenue Cost of sales: Joint production costs Less by-product NRV Adjusted cost of sales Gross margin

? ? ? ?

By-product NRV = $1,500 – $400 = $1,100

By-Product Accounting Method 2 1 $ 170,000 $ 170,000 0 1,100 170,000 171,100 100,000 ? ? ?

100,000 ? ? ?

Joint production costs = $50,000 material + $50,000 conversion 37

Accounting for By-Products

Major product revenue Other revenue Total revenue Cost of sales: Joint production costs Less by-product NRV Adjusted cost of sales Gross margin

By-Products: Some Complications The preceding example assumes the by-product has been sold.

By-Product Accounting Method 2 1 $ 170,000 $ 170,000 0 1,100 170,000 171,100 100,000 1,100 98,900 $ 71,100

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If the by-product is unsold . . .

100,000 0 100,000 $ 71,100

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

Using method 1, the $1,100 by-product NRV is placed in a by-product inventory account.



Using method 2, the $1,100 by-product NRV is deducted from finished goods inventory or work-in-process inventory if unfinished.

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Irrelevance of Joint Costs for Decision Making

Irrelevance of Joint Costs for Decision Making

Decision to “sell products at split off or process them further”

Data about Sawmill’s joint products includes:

Sawmill, Inc. cuts logs from which unfinished lumber and wood chips are the joint products.

Sale s va lue a t the split-off point Sale s va lue a fter furthe r proce ssing Allocate d joint product costs Cost of furthe r proce ssing

Unfinished lumber is sold “as is” or processed further into finished lumber. Wood chips can also be sold “as is” for landscaping or processed further into 4 ×× 8 composition boards.

Pe r Log W ood Lum ber Chips $ 140 $ 40 270 50 176 24 50 20

Question: Should Sawmill sell the products at split-off or after further processing? 41

Irrelevance of Joint Costs for Decision Making

Irrelevance of Joint Costs for Decision Making

Should we include the joint cost in this analysis? 

Ana lysis of Sell or Proce ss Furthe r

NO. That is a sunk cost to the sell or process further decision.

Decision Criteria for sell or process further decision: 

Process further if: 

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Pe r Log W ood Lum ber Chips Sa les va lue a fter furthe r proce ssing $ 270 $ 50 Sa les va lue a t the split-off point 140 40 Incre me nta l re ve nue 130 10 Cost of further proce ssing 50 20 Profit (loss) from furthe r proce ssing $ 80 $ (10)

incremental revenue > incremental processing costs

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Irrelevance of Joint Costs for Decision Making Ana lysis of Sell or Proce ss Furthe r

End of Topic

Pe r Log W ood Lum ber Chips Sa les va lue a fter furthe r proce ssing $ 270 $ 50 Sa les va lue a t the split-off point 140 40 Incre me nta l re ve nue 130 10 Cost of furthe r proce ssing 50 20 Profit (loss) from furthe r proce ssing $ 80 $ (10)

Should we process the lumber further and sell the wood chips “as is?” 45

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