Presentation on theme: "Cost Allocation: Joint Products and By-products"— Presentation transcript:
1 Cost Allocation: Joint Products and By-products ACCT7320Dr. Bailey
2 Nature of Cost Allocations Pervasive in accountingAcross time (depreciation)Between departments (e.g., service depts)To products, customers, branch offices, etc.Often arbitraryMay mislead in decision making
3 Criteria to Guide Cost-Allocation Decisions Cause-and-effect:Using this criterion, managers identify thevariable or variables that cause resourcesto be consumed.Benefits-received:Using this criterion, managers identify thebeneficiaries of the outputs of the cost object.
4 Criteria to Guide Cost-Allocation Decisions Fairness or equity:This criterion is often cited on governmentcontracts when cost allocations are the basisfor establishing a price satisfactory to thegovernment and its suppliers.Ability to bear:This criterion advocates allocating costs in proportionto the cost object’s ability to bear them.
5 Role of Dominant Criteria The cause-and-effectand the benefits-received criteriaguide mostdecisions relatedto cost allocations.Fairness and abilityto bear are lessfrequently used.Why?
6 Role of Dominant Criteria Fairness is an especially difficult criterionto obtain agreement on.The ability to bear criterion raises issuesrelated to cross-subsidization across usersof resources in an organization.
7 Joint CostsThis “joint cost” problem arises when companies inescapably produce two or more products simultaneously out of the same process.How do they allocate costs to jointly-produced products.How are the resulting allocations useful?
8 Joint-Cost BasicsJoint costs are the costs of a single production process that yields multiple products simultaneously.Industries abound in which a single production process simultaneously yields two or more products.
11 Joint-Cost BasicsThe outputs of a joint production process fall into two general categories:Joint products—those that the company is in business to produce (higher total value)By-products—those that also emerge (lesser value)
12 Splitoff PointThe splitoff point is the juncture in the production process where one or more products in a joint-cost setting become separately identifiable.Separable costs are all costs (manufacturing, marketing, distribution, etc.) incurred beyond the splitoff point that are assignable to one or more individual products.
13 Joint Products and By-products Joint products have relatively high sales value at the splitoff point.Main product is the result of a joint production process that yields only one product with a relatively high sales value.By-products are incidental products resulting from the processing of another product.
14 Joint Products and By-products A by-product has a relatively low sales value compared with a joint or main product.Revenue from byproducts generally reduces the costs of the joint products. We aren’t studying the details.Some outputs of the joint production process have zero sales value.“Waste” can be ignored in accounting
15 Joint Products and By-products Main orJoint ProductsBy-productsHighLowSales Value
16 Joint Products and By-products To reiterate: sales value determines the classificationProducts can change from by-products to joint products when their relative sales values increases, and vive-versaKerosene once main product of petroleum
17 Why Allocate Joint Product Costs? The purposes for allocating joint costs to products include:Inventory costingImportant for financial accounting purposes, reports to income tax authorities, and internal reporting purposes.Cost reimbursement contractsCost allocation is required for cost reimbursement purposes under contracts when only a portion of a business’ products or services is sold or delivered to a single customer (government agency).
18 Why Allocate Joint Product Costs? Insurance settlementsRequire cost allocation when damage/loss claims made by manufacturer: What was the “cost”?Rate regulationIf one or more of the jointly produced products or services are subject to price regulation (nat. gas).LitigationJoint cost allocation is important in litigation involving one or more joint products.
19 How to Allocate Joint Costs? The two basic approaches to allocating joint costs are:Use market-based data such as relative product revenues.“Sales value at splitoff”“Estimated net realizable value”Use physical measures such as weight or volume.
20 Allocating Joint Costs Lubbock Company incurred $200,000 of joint costs to produce the following:Product A: 10,000 units, 20,000 poundsProduct B: 10,500 units, 48,000 poundsProduct C: 11,500 units, 12,000 pounds
21 Sales Value at Splitoff Method Allocates joint costs to joint products on the basis of the relative total sales value at the splitoff point.All outputs must have sales values at this point to use the method.
22 Sales Value at Splitoff Method Assume the following sales values per unit: A: $10.00, B: $30.00, and C: $20.00What is the total sales value at splitoff point?Product A: 10,000 × $10.00 = $100, %Product B: 10,500 × $30.00 = 315, %Product C: 11,500 × $20.00 = 230, %Total $645, %
23 Sales Value at Splitoff Method How much joint costs are allocated to each product?A: 15.5%× $200,000 = $ 31,008B: 48.8% × $200,000 = 97,674C: 35.7% × $200,000 = 71,318Total $200,000
24 Sales Value at Splitoff Method What are the joint production costs per unit?Product A: $31,008 ÷ 10,000 = $3.10Product B: $97,674 ÷ 10,500 = $9.30Product C: $71,318 ÷ 11,500 = $6.20
25 Sales Value at Splitoff Method Assume all of the units produced of B and C were sold (no further processing).2,500 units of A (25%) remain in inventory.What is the gross margin percentage of each product?
26 Sales Value at Splitoff Method Product ARevenues: 7,500 units × $10.00 $75,000Cost of goods sold:Joint product costs $31,008Less ending inventory 7,752* 23,256*$31,008 × 25%Gross margin $51,744
27 Sales Value at Splitoff Method Prod. A: $75,000 – $ 23,256 = $51,744; $51,744 ÷ $75,000 = 69%Prod. B: ($315,000 – $97,674) ÷ $315,000 = 69%Prod. C: ($230,000 – $71,318) ÷ $230,000 = 69%The sales value at splitoff method produces an identical gross margin percentage for each product.
28 Estimated Net Realizable Value (NRV) Method Often products are processed further beyond the splitoff point to make them marketable or increase their value.
29 Estimated Net Realizable Value (NRV) Method The estimated NRV method allocates joint costs to joint products on the basis of the relative estimated NRV.NRV = (expected final sales value in the ordinary course of business) – (expected separable costs of the total production of these products)
30 Absolute Irrelevance of Joint Costs for Decision Making Joint costs incurred up to the splitoff point are past (sunk) costs irrelevant to the decision to sell a joint (or main) product at the splitoff point or to process it further.
31 Irrelevance of Joint Costs for Decision Making Assume that products A, B, and C can be sold at the splitoff point (at price1) or processed further into A1, B1, and C1 and sold at price2.Units price price Add’l costs10,000 A: $10 A1: $12 $35,00010,500 B: $30 B1: $33 $46,50011,500 C: $20 C1: $21 $51,500
32 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, – Incremental cost $35,000 = ($15,000)Product B: Incremental revenue $31, – Incremental cost $46,500 = ($15,000)Product C: Incremental revenue $11, – Incremental cost $51,500 = ($40,000)
33 Irrelevance of Joint Costs for Decision Making Products A, B, and C should be sold at the splitoff point.No techniques for allocating joint-product costs can guide decisions about whether a product should be sold at the splitoff point or processed beyond splitoff.