Cost Accounting: A Managerial Emphasis

COST ACCOUNTING
A Managerial Emphasis
Seventh Canadian Edition
HORNGREN, DATAR, RAJAN, BEAUBIEN, GRAHAM

Chapter 15

Cost Allocation:
Joint Products and Byproducts
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 Cost Accounting: A Managerial Emphasis

Learning Objectives

11. Distinguish among different types of saleable

products, scrap, and toxic waste.
22. Analyze the physical measure and sales value at

splitoff methods to allocate joint costs.

33. Analyze the two methods to use when there is no

sales value at the splitoff point.

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Learning Objectives

41. Understand the irrelevance of joint costs in

the “sell of process further” decision.
52. Identify the strategic implications of a decision

to implement one joint cost allocation method.

63. Account for byproducts using two different
methods.

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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 one or more individual products

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Joint Cost Terminology

• Categories of joint process outputs:

– Outputs with a positive sales value
– Outputs with a zero sales value
• Product
– Any output with a positive sales value, or an output
used internally that enables a firm to avoid incurring
costs
• Value can be high or low

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Joint Cost Terminology

• 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
• But are not separately identifiable as individual products
until the split-off point
• Main Product
– Output of a joint production process that yields
one product with a high sales value compared to
the values of the other outputs

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Joint Cost Terminology

• Byproduct
– Outputs of a joint production process that have a low
sales value compared to the sales values of other
outputs (i.e., the main or joint products)
• Scrap
– Has a minimal to zero sales value
• Toxic Waste
– Has negative revenue when the costs of reclamation
and remediation are considered
– Costs of recovering or disposing of toxic emissions are
life-cycle costs that should be added to joint production
costs prior to allocating this cost pool to main, joint, or
byproducts
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Industries Incurring Joint Costs

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Reasons for Allocating Joint Costs

• Required for GAAP and taxation purposes

• Computation of inventoriable costs and cost
of goods sold for financial accounting and tax
reporting
• Internal analysis of divisional profitability
• Cost-based contracting
• Insurance settlements
• Required for rate and price regulations
• Litigation
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Joint Process Flowchart

Steam:
An Output with Zero Sales Value

Not recorded Joint Product #1

to books

Splitoff point

Single Production
Process

Joint Product #2

Byproduct

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Joint Cost Allocation Methods

• Market-based — allocate using market-

derived data (dollars):
1. Sales value at splitoff
2. 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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Joint Cost — Illustration Overview

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Joint Cost — Illustration Data

Joint Costs
Joint costs (costs of 4,400 hL of raw milk
and processing to splitoff point) $ 345,000
Cream Liquid Skim
Beginning inventory (hectolitres) 0 0
Production (hL) 1,000 3,000
Sales (hL) 800 900
Ending inventory (hL) 200 2,100
Selling price per hL $155.00 $75.00

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Physical Measure Method

• Allocates joint costs on the basis of their

relative proportions at the splitoff point
– Using a common physical measure such as
weight or volume
• Less desirable as physical allocation
measure has no relationship to revenue-
producing power of the individual products
• Can be problematic if no common physical
measure is available

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Physical Measure — Example

Cream Skim Total

Physical Measure of Production 1,000 3,000 4,000
Weighting 0.25 0.75
Joint Costs Allocated:
Joint Cost X Weighting $ 86,250 $ 258,750 $ 345,000
Joint production cost per hL $ 86.25 $ 86.25

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Sales Value at Splitoff Method

• Uses the sales value of the entire production

in the accounting period to calculate
allocation percentage
– Costs are allocated to products in proportion to
their revenue-generating power
– Consistent with the benefits-received criterion of
cost allocation
• Ignores inventories

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Sales Value at Splitoff — Example

Cream Skim Total

Sales Value of Production
Cream: 1,000 hL@ $155/hL $ 155,000
Skim: 3,000 hL@ $75/hL $ 225,000
Total $ 380,000
Allocation Based on % of
Total Sales (rounded) 40.79% 59.21%

Joint Costs Allocated:

Joint Cost X Allocation % $ 140,724 $ 204,276 $ 345,000
Joint production cost per hL $ 140.72 $ 68.09

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Net Realizable Value Method

• Allocates joint costs on the basis of relative

estimated net realizable value (NRV) of total
production of the joint products
– Expected sales value less expected separable
costs of production and marketing of total
production
NRV = Final Sales Value – Separable Costs
• An alternative when selling prices of one or
more products at splitoff do not exist

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NRV — Example

Buttercream Condensed Milk Total

Final Sales Value of Production
Buttercream: 800 hL@ $420/hL $ 336,000
Condensed milk: 2,000 hL@ $305/hL $ 610,000
Total $ 946,000
Less: Separable Costs 135,000 270,000 405,000
NRV 201,000 340,000 541,000
NRV Weighting:
Product NRV ÷ Total NRV 37.15% 62.85%
Joint Costs Allocated $ 128,179 $ 216,821 $ 345,000
Production Cost per hL $ 328.97 $ 243.41

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Constant Gross Margin % of

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

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Constant Gross Margin % of NRV

Method — Example
Final Sales Value of Production
Buttercream: 800 hL @ $420/hL $ 336,000
Condensed milk: 2,000 hL @ $305/hL $ 610,000
Total $ 946,000
Less: Joint and separable costs ($345,000+$135,000+$270,000) 750,000

Gross margin $ 196,000

Gross margin percentage 20.719%

Buttercream Condensed milk Total

Sales values $ 336,000 $ 610,000 $ 946,000
Less gross margin @ 20.719% 69,615 126,385 196,000

Total Product Costs $ 266,385 $ 483,615 $ 750,000

Less Separable Costs 135,000 270,000 405,000
Joint Costs Allocated $ 131,385 $ 213,615 $ 345,000

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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.

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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 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

Final
Joint Product #1 Product
#1
Further Processing Dept 1

Single Production
Process Final
Joint Product #2 Product
#2
Further Processing Dept 2

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Sell-or-Process Further
Income Statement Example

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Accounting Challenges

• Market-based joint cost allocation methods

result in positive operating incomes for all
products
• Allocating joint costs using physical measures
can result in one or more joint products
having negative operating income
• Implication for performance evaluation:
– Managers may be reluctant to be responsible for
products with negative margins

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Byproducts

• Two methods for accounting for byproducts:

1. Production method
• Recognizes byproduct inventory as it is produced,
and sales and costs at the time of sale
• Recorded as inventory at their selling price, or at
selling price less normal profit margin
2. Sales method
• Delays recognition of byproducts until they are sold;
byproduct costs are not tracked separately
• Byproduct inventory is not recognized
• Revenue is recorded at the time of sale

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Income Statement — Byproducts

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