1. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9 Joint-Process Costing McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

2. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-2 Single Input Product 1 Product 2 Product 3 Joint Product Processes A number of products are produced from a single raw material input.

3. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-3 Concept: in some industries, a number of products are produced from a single raw material input. Key terms: Joint products – products resulting from a process with a common input. Split-off point – the stage of processing where joint products are separated. Joint cost – costs of processing joint products prior to the split-off point. Final product – ready for sale without further processing. Intermediate product – requires further processing before sale. Concept: in some industries, a number of products are produced from a single raw material input. Key terms: Joint products – products resulting from a process with a common input. Split-off point – the stage of processing where joint products are separated. Joint cost – costs of processing joint products prior to the split-off point. Final product – ready for sale without further processing. Intermediate product – requires further processing before sale. Joint Product Processes

4. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-4 Consider the following example of an oil refinery. We will assume only two products, gasoline and oil. Joint Product Processes

5. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-5 Joint Input Common Production Process Split-Off Point Joint Costs Joint Product Processes Oil Gasoline Intermediate products Final Sale Final Sale Separate Processing Separate Processing Costs Separate Processing Separate Processing Costs Final products

6. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-6 The Decision Challenge: Which Joint Products to Produce The usual objective in the production of joint products is to maximize profits.  Identify final products possible from the joint process.  Forecast the sales price of each final product.  Estimate costs to further process joint products into final products.  Choose the set of products with the overall maximum profit.

7. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-7 Decision to Sell Products at Split Off or Process Them Further Joint product costs incurred prior to the split-off point are sunk costs — not affected by a decision to process further after the split-off point. A product should be processed beyond the split-off point only if if the incremental revenue exceeds the incremental processing costs. Joint product costs incurred prior to the split-off point are sunk costs — not affected by a decision to process further after the split-off point. A product should be processed beyond the split-off point only if if the incremental revenue exceeds the incremental processing costs. Value is added only if the incremental value from processing exceeds the incremental processing costs.

8. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-8 Sawmill, Inc. cuts logs from which unfinished lumber and wood chips are the joint products. 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. Sawmill, Inc. cuts logs from which unfinished lumber and wood chips are the joint products. 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. Decision to Sell Products at Split Off or Process Them Further

9. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-9 Data about Sawmill’s joint products includes: Decision to Sell Products at Split Off or Process Them Further

10. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-10 Decision to Sell Products at Split Off or Process Them Further

11. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-11 Should we process the lumber further and sell the wood chips “as is?” Decision to Sell Products at Split Off or Process Them Further

12. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-12  To measure performance based on earnings.  To value inventory for financial statements.  Casualty loss estimation.  Determining and responding to rate regulation.  Specifying and resolving contractual interests and obligations.  To measure performance based on earnings.  To value inventory for financial statements.  Casualty loss estimation.  Determining and responding to rate regulation.  Specifying and resolving contractual interests and obligations. Reasons for Allocating Joint Costs

13. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-13 Monetary measure method Joint costs are allocated based on the relative values of the products at the split-off point. Joint costs are allocated based on a proportional measure (weight, volume, etc.) of the joint products at the split-off point. Physical measure method Joint Cost Allocation Methods

14. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-14 Joint costs Allocation If we allocate the joint costs of raising an animal to the two products based on weight, which product would receive the largest cost allocation? Hamburger, because there is more of it. Allocating Joint Costs

15. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-15 If we allocate the joint costs of raising the animal to the two products based on sales value, would the steak receive a greater portion of the cost allocation? Yes, steak has a higher sales value than hamburger. Joint costs Allocation Allocating Joint Costs

16. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-16 Let’s look at an example illustrating the joint cost allocation methods. Joint Cost Allocation Methods

17. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-17 The physical measure method may be used when  Output product prices are highly volatile.  Many additional processes occur between the split-off point and the first point of marketability.  Market prices are unavailable for products such as on cost-plus contracts. The physical measure method may be used when  Output product prices are highly volatile.  Many additional processes occur between the split-off point and the first point of marketability.  Market prices are unavailable for products such as on cost-plus contracts. Physical Measure Method

18. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-18 Joint Input Common Production Process Split-Off Point Joint Costs Oil Gasoline 240,000 gallons 360,000 gallons Physical Measure Method

19. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-19 Common Production Process 240,000 gallons 360,000 gallons Joint material cost = $275,000 Joint conversion cost = $225,000 Oil Gasoline Split-Off Point Physical Measure Method

20. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-20 Physical Measure Method

21. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-21 Physical Measure Method

22. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-22 $275,000 joint material cost plus $225,000 joint conversion cost Physical Measure Method

23. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-23 If products require further processing beyond the split-off point before they are marketable, it may be necessary to estimate the net realizable value (NRV) at the split-off point. NRV Final Sales Value Added Processing Costs –= Monetary Measure Method Net Realizable Value

24. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-24 Joint Input Common Production Process Split-Off Point Joint Costs OilGasoline Intermediate products Final Sale Final Sale Separate Processing Separate Processing Costs Separate Processing Separate Processing Costs Final products Monetary Measure Method Net Realizable Value

25. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-25 Common Production Process Split-Off Point OilGasoline Separate Processing Separate Processing Monetary Measure Method Net Realizable Value Sales Value $500,000 Separate Processing Costs $500,000 Separate Processing Costs $200,000 Joint material cost = $275,000 Joint conversion cost = $225,000 Sales Value $1,200,000

26. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-26 Monetary Measure Method Net Realizable Value

27. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-27 Monetary Measure Method Net Realizable Value

28. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-28 Monetary Measure Method Net Realizable Value

29. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-29 Monetary Measure Method Net Realizable Value

30. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-30 Monetary Measure Method Net Realizable Value

31. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-31 The net realizable value method results in equal gross margin percentages for all products. Monetary Measure Method Net Realizable Value

32. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-32 Which joint cost allocation method should we use? We get a different result with each method. Choosing Among Joint Cost Allocation Methods Joint costs are truly common costs. It is impossible to separate the portion of joint costs attributable to one product on a cause and effect basis.

33. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-33 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. Choosing Among Joint Cost Allocation Methods

34. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-34 Do not base product or service production decisions on joint margins (I.e., after joint-cost allocation) unless the choice is in responses to regulatory opportunities. Do not base product or service production decisions on joint margins (I.e., after joint-cost allocation) unless the choice is in responses to regulatory opportunities. Choose the joint-cost allocation method that maximizes regulated profits of cost reimbursements. Choose the joint-cost allocation method that maximizes regulated profits of cost reimbursements. Clearly define how to allocate joint costs in contractual agreements among parties that share outputs and joint costs of joint processes. Clearly define how to allocate joint costs in contractual agreements among parties that share outputs and joint costs of joint processes. Choosing Among Joint Cost Allocation Methods

35. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-35 Accounting for By-Products By-products are incidental products with minimal sales value compared to the major products. Do not allocate joint costs to by-products

36. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-36 Two commonly used methods of accounting for by-products are...  Realized Value Approach By-product NRV is treated as other revenue.  Net Realizable Value Approach By-product NRV is deducted from joint production costs before allocation. 1 2 Accounting for By-Products

37. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-37 By-products Major Product Common Production Process Split-Off Point Joint Input Joint Costs Accounting for By-Products Relatively low value or quantity when compared to major products

38. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-38 Sales Value $100,000 Separate Processing Separate Processing Costs $400 Joint Material cost = $50,000 Joint conversion cost = $50,000 Sales Value $1,500 Sales Value $70,000 By-products Major Product Common Production Process Split-Off Point Accounting for By-Products

39. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-39 Accounting for By-Products Major product revenue = $100,000 + $70,000

40. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-40 Accounting for By-Products By-product NRV = $1,500 – $400 = $1,100

41. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-41 Accounting for By-Products Joint production costs = $50,000 material + $50,000 conversion

42. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-42 Accounting for By-Products

43. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-43 By-Products: Some Complications The preceding example assumes the by- product has been sold. If the by-product is unsold... Using method 2, the $1,100 by-product NRV is deducted from finished goods inventory or work-in-process inventory if unfinished. Using method 1, the $1,100 by-product NRV is placed in a by-product inventory account. The preceding example assumes the by- product has been sold. If the by-product is unsold... Using method 2, the $1,100 by-product NRV is deducted from finished goods inventory or work-in-process inventory if unfinished. Using method 1, the $1,100 by-product NRV is placed in a by-product inventory account.

44. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-44 Waste is a by-product with negative NRV. (Cost of disposal exceeds sales value) Waste is disposed of at minimum cost. Waste disposal cost is charged to manufacturing overhead and applied to other products as part of the manufacturing overhead allocation process. Waste is a by-product with negative NRV. (Cost of disposal exceeds sales value) Waste is disposed of at minimum cost. Waste disposal cost is charged to manufacturing overhead and applied to other products as part of the manufacturing overhead allocation process. Disposal of Scrap or Waste

45. The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin 9-45 End of Chapter 9