Chapter 16

Cost Allocation:
Joint Products and
Byproducts

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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

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Cost

Joint-Cost Basics
Joint costs

Joint products

Byproduct

Splitoff point

Separable costs
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Cost

Joint-Cost Basics
Coal

Gas

Benzyl

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Tar

Cost

Joint-Cost Basics
Timber (logs)

2x4s

1x8 clear

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Bark

Cost

Joint Products and Byproducts

Main Products
Joint Products

Byproducts

High

Low
Sales Value

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Cost

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

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Cost

Approaches to Allocating
Joint Costs
Two basic ways to allocate
joint costs to products are:

Approach 1:
Market based
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Approach 2:
Physical measure
Cost

Approach 1: Market-based Data

(3 ways)
Sales value at splitoff method
Estimated net realizable value (NRV) method
Constant gross-margin percentage NRV method

2009 Foster School of Business

Cost

Allocating Joint Costs Example

10,000 units of A at a
selling price of $10 = $100,000
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
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Joint processing
cost is $200,000

Splitoff point
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Allocating Joint Costs Example

(Sales-Value-at-Splitoff method)
Sales Value
Allocation of
Joint Cost:
100 645
315 645
230 645
Gross margin

A
B
C
Total
$100,000 $315,000 $230,000 $645,000

31,008
97,674
71,318
200,000
$ 68,992 $217,326 $158,682 $445,000

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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:
B1:
C1:
10,000 $12.00 10,500 $33.00 11,500 $21.00
= $120,000
= $346,500
= $241,500
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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?
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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?
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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
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Estimated Net Realizable Value

(NRV) Method Example

A1
B1
C1
Total

Allocated
joint costs
$ 29,565
104,348
66,087
$200,000

Separable
costs
$ 35,000
46,500
51,500
$133,000

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Inventory
costs
$ 64,565
150,848
117,587
$333,000
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Constant Gross-Margin
Percentage 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.
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Constant Gross-Margin
Percentage NRV Method
Step 3:
Deduct the expected separable costs from the
total costs to obtain the joint-cost allocation.

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Constant Gross-Margin
Percentage NRV Method
What is the expected final sales value of total
production during the accounting period?
Product A1:
Product B1:
Product C1:
Total
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$120,000
346,500
241,500
$708,000
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Constant Gross-Margin
Percentage 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%
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Constant Gross-Margin
Percentage NRV Method
Step 2:
Deduct the gross margin.
Sales
Gross
Cost of
Value
Margin Goods 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)

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Constant Gross-Margin
Percentage NRV Method
Step 3:
Deduct separable costs.
Cost of Separable Joint costs
goods sold
costs
allocated
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
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Constant GM % NRV method

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

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Approach 2: Physical
Measure 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

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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.

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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.

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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?)

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Irrelevance of Joint Costs

for 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
Units
price (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.

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Irrelevance of Joint Costs

for 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)
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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.
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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.
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Accounting for Byproducts

Byproducts have low sales value.
Cost-benefit analysis often times leads to the
use of the most expedient method.

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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?

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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.

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End of Chapter 16

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