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Cost Allocation: Joint Products and Byproducts. Chapter 16. Joint Costing Overview. Terminology Joint cost examples Joint versus Byproducts Ways to allocate: Sales-value at Splitoff NRV Constant Gross Margin % Physical Measure Accounting for Byproducts. Joint-Cost Basics.

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joint costing overview
Joint Costing Overview
  • Terminology
  • Joint cost examples
  • Joint versus Byproducts
  • Ways to allocate:
    • Sales-value at Splitoff
    • NRV
    • Constant Gross Margin %
    • Physical Measure
  • Accounting for Byproducts
joint cost basics
Joint-Cost Basics

Joint costs

Joint products

Byproduct

Splitoff point

Separable costs

joint cost basics4
Joint-Cost Basics

Coal

Gas

Benzyl

Tar

joint cost basics5
Joint-Cost Basics

Timber (logs)

2x4s

1x8 clear

Bark

joint products and byproducts
Joint Products and Byproducts

Main Products

Joint Products

Byproducts

High

Low

Sales Value

why allocate joint costs
Why Allocate Joint Costs?
  • to compute inventory cost and cost of goods sold
  • to determine cost reimbursement under contracts
  • for insurance settlement computations
  • for rate regulation
  • for litigation purposes
approaches to allocating joint costs
Approaches to AllocatingJoint Costs

Two basic ways to allocate

joint costs to products are:

Approach 2:

Physical measure

Approach 1:

Market based

approach 1 market based data 3 ways
Approach 1: Market-based Data (3 ways)

Sales value at splitoff method

Estimated net realizable value (NRV) method

Constant gross-margin percentage NRV method

allocating joint costs example
Allocating Joint Costs Example

10,000 units of A at a

selling price of $10 = $100,000

Joint processing

cost is $200,000

10,500 units of B at a

selling price of $30 = $315,000

11,500 units of C at a

selling price of $20 = $230,00

Splitoff point

allocating joint costs example sales value at splitoff method
Allocating Joint Costs Example(Sales-Value-at-Splitoff method)

A B C Total

Sales Value $100,000 $315,000 $230,000 $645,000

Allocation of

Joint Cost:

100 ÷ 645 31,008

315 ÷ 645 97,674

230 ÷ 645 71,318

200,000

Gross margin $ 68,992 $217,326 $158,682 $445,000

estimated net realizable value nrv method example
Estimated Net Realizable Value (NRV) Method Example

Assume that the Company can process

products A, B, and, C further into A1, B1, and C1.

The new sales values after further processing are:

A1:

10,000 × $12.00

= $120,000

B1:

10,500 × $33.00

= $346,500

C1:

11,500 × $21.00

= $241,500

estimated net realizable value nrv method example13
Estimated Net Realizable Value (NRV) Method Example

Additional processing (separable) costs are as follows:

A1: $35,000

B1: $46,500

C1: $51,500

What is the estimated net realizable value of each

product at the splitoff point?

estimated net realizable value nrv method example14
Estimated Net Realizable Value (NRV) Method Example

Product A1: $120,000 – $35,000 = $ 85,000

Product B1: $346,500 – $46,500 = $300,000

Product C1: $241,500 – $51,500 = $190,000

How much of the joint cost is allocated

to each product?

estimated net realizable value nrv method example15
Estimated Net Realizable Value (NRV) Method Example

Joint cost allocated To A1:

85 ÷ 575 × $200,000 = $ 29,565

To B1:

300 ÷ 575 × $200,000 = $104,348

To C1:

190 ÷ 575 × $200,000 = $ 66,087

estimated net realizable value nrv method example16
Estimated Net Realizable Value (NRV) Method Example

Allocated Separable Inventory

joint costscostscosts

A1 $ 29,565 $ 35,000 $ 64,565

B1 104,348 46,500 150,848

C1 66,087 51,500 117,587

Total $200,000 $133,000 $333,000

constant gross margin percentage nrv method
Constant Gross-MarginPercentage NRV Method

This method entails three steps:

Step 1:

Compute the overall gross-margin percentage.

Step 2:

Use the overall gross-margin percentage

and deduct the gross margin from the

final sales values to obtain the total

costs that each product should bear.

constant gross margin percentage nrv method18
Constant Gross-MarginPercentage NRV Method

Step 3:

Deduct the expected separable costs from the

total costs to obtain the joint-cost allocation.

constant gross margin percentage nrv method19
Constant Gross-MarginPercentage NRV Method

What is the expected final sales value of total

production during the accounting period?

Product A1: $120,000

Product B1: 346,500

Product C1: 241,500

Total $708,000

constant gross margin percentage nrv method20
Constant Gross-MarginPercentage NRV Method

Step 1:

Compute the overall gross-margin percentage.

Expected final sales value $708,000

Deduct joint and separable costs 333,000

Gross margin $375,000

Gross margin percentage:

$375,000 ÷ $708,000 = 52.966%

constant gross margin percentage nrv method21
Constant Gross-MarginPercentage NRV Method

Step 2:

Deduct the gross margin.

Sales Gross Cost of

ValueMarginGoods sold

Product A1: $120,000 $ 63,559 $ 56,441

Product B1: 346,500 183,527 162,973

Product C1: 241,500 127,913 113,587

Total $708,000 $375,000 $333,000

($1 rounding)

constant gross margin percentage nrv method22
Constant Gross-MarginPercentage NRV Method

Step 3:

Deduct separable costs.

Cost of Separable Joint costs

goods soldcostsallocated

Product A1: $ 56,441 $ 35,000 $ 21,441

Product B1: 162,973 46,500 116,473

Product C1: 113,587 51,500 62,087

Total $333,000 $133,000 $200,000

constant gm nrv method
Constant GM % NRV method

Something that causes most students to “pause” can happen when using this method to allocate joint costs, what is it????

approach 2 physical measure method example
Approach 2: PhysicalMeasure Method Example

$200,000 joint cost

20,000

pounds A

48,000

pounds B

12,000

pounds C

Product A

$50,000

Product B

$120,000

Product C

$30,000

choosing a method
Choosing a Method

Why is the sales value at splitoff method widely used?

It measures the value

of the joint product

immediately.

It does not anticipate

subsequent management

decisions.

It uses a

meaningful basis.

It is simple.

choosing a method26
Choosing a Method

The purpose of the joint-cost allocation is

important in choosing the allocation method.

The physical-measure method is a more

appropriate method to use in rate regulation.

avoiding joint cost allocation
Avoiding Joint Cost Allocation

Some companies refrain from allocating joint

costs and instead carry their inventories

at estimated net realizable value.

(This is the “ceiling” of LCM rule.

What is the “floor?”)

irrelevance of joint costs for decision making
Irrelevance of Joint Costsfor Decision Making

Assume that products A, B, and C can be sold

at the splitoff point or processed further

into A1, B1, and C1.

Selling Selling Additional

Unitsprice(1)price (2)costs

10,000 A: $10 A1: $12 $35,000

10,500 B: $30 B1: $33 $46,500

11,500 C: $20 C1: $21 $51,500

(1) value at splitoff; (2) value after processing further.

irrelevance of joint costs for decision making29
Irrelevance of Joint Costsfor Decision Making

Should A, B, or C be sold at the splitoff

point or processed further?

Product A: Incremental revenue $20,000

– Incremental cost $35,000 = ($15,000)

Product B: Incremental revenue $31,500

– Incremental cost $46,500 = ($15,000)

Product C: Incremental revenue $11,500

– Incremental cost $51,500 = ($40,000)

accounting for byproducts
Accounting for Byproducts

Method A:

The production method recognizes byproducts

at the time their production is completed.

Method B:

The sale method delays recognition of

byproducts until the time of their sale.

accounting for byproducts31
Accounting for Byproducts

Neither approach is conceptually correct.

Both technically violate GAAP.

Method A:

Recognizes byproducts revenue

at the time their production is completed.

Method B:

Does not recognize byproducts in inventory.

accounting for byproducts32
Accounting for Byproducts

Byproducts have low sales value.

Cost-benefit analysis often times leads to the use of the most expedient method.

accounting for byproducts33
Accounting for Byproducts

An alternative approach that would follow GAAP would be to treat byproducts as if they were joint products (i.e., use the same joint cost allocation method for all products.

This is not common practice, why?

accounting for byproducts34
Accounting for Byproducts
  • Byproduct revenues appear in the income statement as either:
  • Cost reduction for the main product, or
  • Separate item of revenue or other income.