2. 2009 Foster School of Business Cost Accounting L.DuCharme 1 Cost Allocation: Joint Products and Byproducts Chapter 16

3. 2009 Foster School of Business Cost Accounting L.DuCharme 2 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

4. 2009 Foster School of Business Cost Accounting L.DuCharme 3 Joint-Cost Basics Joint productsJoint costs Separable costs Splitoff point Byproduct

5. 2009 Foster School of Business Cost Accounting L.DuCharme 4 Joint-Cost Basics Coal GasBenzylTar

6. 2009 Foster School of Business Cost Accounting L.DuCharme 5 Joint-Cost Basics Timber (logs) 2x4s1x8 clearBark

7. 2009 Foster School of Business Cost Accounting L.DuCharme 6 Joint Products and Byproducts Sales Value High Low Main Products Joint Products Byproducts

8. 2009 Foster School of Business Cost Accounting L.DuCharme 7 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

9. 2009 Foster School of Business Cost Accounting L.DuCharme 8 Approaches to Allocating Joint Costs Approach 2: Physical measure Approach 1: Market based Two basic ways to allocate joint costs to products are:

10. 2009 Foster School of Business Cost Accounting L.DuCharme 9 Approach 1: Market-based Data (3 ways) Sales value at splitoff method Estimated net realizable value (NRV) method Constant gross-margin percentage NRV method

11. 2009 Foster School of Business Cost Accounting L.DuCharme 10 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 Joint processing cost is $200,000 Splitoff point

12. 2009 Foster School of Business Cost Accounting L.DuCharme 11 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

13. 2009 Foster School of Business Cost Accounting L.DuCharme 12 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

14. 2009 Foster School of Business Cost Accounting L.DuCharme 13 Estimated Net Realizable Value (NRV) Method Example Additional processing (separable) costs are as follows: A1: $35,000B1: $46,500C1: $51,500 What is the estimated net realizable value of each product at the splitoff point?

15. 2009 Foster School of Business Cost Accounting L.DuCharme 14 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?

16. 2009 Foster School of Business Cost Accounting L.DuCharme 15 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

17. 2009 Foster School of Business Cost Accounting L.DuCharme 16 Estimated Net Realizable Value (NRV) Method Example AllocatedSeparableInventory joint costs costs costs 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

18. 2009 Foster School of Business Cost Accounting L.DuCharme 17 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.

19. 2009 Foster School of Business Cost Accounting L.DuCharme 18 Constant Gross-Margin Percentage NRV Method Step 3: Deduct the expected separable costs from the total costs to obtain the joint-cost allocation.

20. 2009 Foster School of Business Cost Accounting L.DuCharme 19 Constant Gross-Margin Percentage 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

21. 2009 Foster School of Business Cost Accounting L.DuCharme 20 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%

22. 2009 Foster School of Business Cost Accounting L.DuCharme 21 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)

23. 2009 Foster School of Business Cost Accounting L.DuCharme 22 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

24. 2009 Foster School of Business Cost Accounting L.DuCharme 23 Constant GM % NRV method Something that causes most students to “pause” can happen when using this method to allocate joint costs, what is it????

25. 2009 Foster School of Business Cost Accounting L.DuCharme 24 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

26. 2009 Foster School of Business Cost Accounting L.DuCharme 25 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.

27. 2009 Foster School of Business Cost Accounting L.DuCharme 26 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.

28. 2009 Foster School of Business Cost Accounting L.DuCharme 27 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?”)

29. 2009 Foster School of Business Cost Accounting L.DuCharme 28 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. SellingSelling Additional Unitsprice (1) price (2) costs 10,000A: $10A1: $12$35,000 10,500B: $30B1: $33$46,500 11,500C: $20C1: $21$51,500 (1) value at splitoff; (2) value after processing further.

30. 2009 Foster School of Business Cost Accounting L.DuCharme 29 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)

31. 2009 Foster School of Business Cost Accounting L.DuCharme 30 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.

32. 2009 Foster School of Business Cost Accounting L.DuCharme 31 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.

33. 2009 Foster School of Business Cost Accounting L.DuCharme 32 Accounting for Byproducts Byproducts have low sales value. Cost-benefit analysis often times leads to the use of the most expedient method.

34. 2009 Foster School of Business Cost Accounting L.DuCharme 33 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?

35. 2009 Foster School of Business Cost Accounting L.DuCharme 34 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.

36. 2009 Foster School of Business Cost Accounting L.DuCharme 35 End of Chapter 16