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This article discusses the different methods of allocating joint costs to joint products and byproducts. It explores the sales value at splitoff method, the net realizable value method, and the decision to not allocate joint costs to products. Additionally, it covers the relevance of joint costs for decision making and the accounting for byproducts.
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The Islamic University –Gaza Cost Allocation: Joint Products and Byproducts Dr. Hisham Madi
Choosing an allocation Method • If selling price at splitoff is available, the sales value at splitoff method is preferred even if further processing is done. Reasons include: • Measurement of the value of the joint products at the splitoff point. Sales value at splitoffis the best measure of the benefits received as a result of joint processing relative to all other methods of allocating joint costs. It is a meaningful basis for allocating joint costs because generating revenues is the reason why a company incurs joint costs in the first place.
Choosing an allocation Method No anticipation of subsequent management decisions. • The sales value at splitoff method does not require information on the processing steps after splitoff if there is further processing Availability of a common basis to allocate joint costs to products Simplicity. The sales value at splitoff method is simple.
Choosing an allocation Method • When selling prices of all products at the splitoff point are unavailable, the NRV method is commonly used because it attempts to approximate sales value at splitoff by subtracting from selling prices separable costs incurred after the splitoff point
Not Allocating Joint Costs • Some companies choose to not allocate joint costs to products. The usual rationale given by these firms is the complexity of their production or extraction processes and the difficulty of gathering sufficient data for carrying out the allocations correctly.
Irrelevance of Joint Costs for Decision Making Sell-or-Process-Further Decisions • Consider Farmers’ Dairy’s decision to either sell the joint products, cream and liquid skim, at the splitoff point or to further process them into buttercream and condensed milk. • The decision to incur additional costs for further processing should be based on the incremental operating income attainable beyond the splitoff point
Irrelevance of Joint Costs for Decision Making • Do not assume all separable costs in joint-cost allocations are always incremental costs
Accounting for Byproducts • Example 3: The Westlake Corporation processes timber into fine-grade lumber and wood chips that are used as mulch in gardens and lawns. Information about these products follows: • Fine-Grade lumber (the main product)—sells for $6 per board foot (b.f.) • Wood chips (the byproduct)—sells for $1 per cubic foot (c.f.) Data for July 2012 are as follows:
Accounting for Byproducts Production Method: Byproducts Recognized at Time Production Is Completed • This method recognizes the byproduct in the financial statements—the 4,000 cubic feet of wood chips—in the month it is produced, July 2012. The NRV from the byproduct produced is offset against the costs of the main product
Accounting for Byproducts • Sales Method: Byproducts Recognized at Time of Sale • This method makes no journal entries for byproducts until they are sold. • Revenues of the byproduct are reported as a revenue item in the income statement at the time of sale. • These revenues are either grouped with other sales, included as other income, or are deducted from cost of goods sold
