1. Cost Allocation: Joint Products and By-products
ACCT7320
Dr. Bailey

2. Nature of Cost Allocations
Pervasive in accounting
Across time (depreciation)
Between departments (e.g., service depts)
To products, customers, branch offices, etc.
Often arbitrary
May mislead in decision making

3. Criteria to Guide Cost-Allocation Decisions
Cause-and-effect:
Using this criterion, managers identify the
variable or variables that cause resources
to be consumed.
Benefits-received:
Using this criterion, managers identify the
beneficiaries of the outputs of the cost object.

4. Criteria to Guide Cost-Allocation Decisions
Fairness or equity:
This criterion is often cited on government
contracts when cost allocations are the basis
for establishing a price satisfactory to the
government and its suppliers.
Ability to bear:
This criterion advocates allocating costs in proportion
to the cost object’s ability to bear them.

5. Role of Dominant Criteria
The cause-and-effect
and the benefits-
received criteria
guide most
decisions related
to cost allocations.
Fairness and ability
to bear are less
frequently used.
Why?

6. Role of Dominant Criteria
Fairness is an especially difficult criterion
to obtain agreement on.
The ability to bear criterion raises issues
related to cross-subsidization across users
of resources in an organization.

7. Joint Costs
This “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 Basics
Joint 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.

9. Joint-Cost Basics
Tomatoes
Tomato juice
Tomato sauce
Tomato paste

10. Joint-Cost Basics
Coal
Gas
Benzol
Tar

11. Joint-Cost Basics
The 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 Point
The 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 or
Joint Products
By-products
High
Low
Sales Value

16. Joint Products and By-products
To reiterate: sales value determines the classification
Products can change from by-products to joint products when their relative sales values increases, and vive-versa
Kerosene once main product of petroleum

17. Why Allocate Joint Product Costs?
The purposes for allocating joint costs to products include:
Inventory costing
Important for financial accounting purposes, reports to income tax authorities, and internal reporting purposes.
Cost reimbursement contracts
Cost 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 settlements
Require cost allocation when damage/loss claims made by manufacturer: What was the “cost”?
Rate regulation
If one or more of the jointly produced products or services are subject to price regulation (nat. gas).
Litigation
Joint 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 pounds
Product B: 10,500 units, 48,000 pounds
Product 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: $20.00
What 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 = $ 31,008
B: 48.8% × $200,000 = 97,674
C: 35.7% × $200,000 = 71,318
Total $200,000

24. Sales Value at Splitoff Method
What are the joint production costs per unit?
Product A: $31,008 ÷ 10,000 = $3.10
Product B: $97,674 ÷ 10,500 = $9.30
Product 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 A
Revenues: 7,500 units × $10.00 $75,000
Cost of goods sold:
Joint product costs $31,008
Less 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 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

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.

34. The End