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Cost Allocation: Joint Products and By-products

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Presentation on theme: "Cost Allocation: Joint Products and By-products"— Presentation transcript:

1 Cost Allocation: Joint Products and By-products

2 Joint-Cost Basics Joint costs Joint products Byproduct Splitoff point
Separable costs

3 Key terms: Joint products – two or more outputs produced simultaneously by a single manufacturing process using common input Split-off point – the stage of processing where joint products are separated. Joint cost – costs of processing two or more products prior to the split-off point; common cost Byproducts– products that result incidentally from the joint products - Separable cost – cost after the split-off point

4 Joint Product Cost Allocation
Consider the following example of an oil refinery. We will assume only two products, gasoline and oil.

5 Joint Product Cost Allocation
Input Production Process Split-Off Point Joint Product Costs Oil Gasoline Final Sale Separate Processing Separate Processing Costs Separate Processing Costs

6 Joint Products and Byproducts
Main Products Joint Products Byproducts High Low Sales Value

7 Relatively low value or quantity when compared to major products
By-Products Joint Input Production Process Split-Off Point Costs By-products Major Product Relatively low value or quantity when compared to major products

8 Explain why joint costs should be allocated to individual products.

9 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

10 Approaches to Allocating Joint Costs
Two basic ways to allocate joint costs to products are: Approach 1: Physical measure Approach 2: Market-based

11 Allocating Joint Costs
Approach 1 a. Physical-Units Method b. Net-Realizable- Value Method Joint Product Costs Approach 2 a. Relative- Sales Value Method c. Gross margin Percent method

12 Physical-Units Method
Allocation based on a physical measure of the joint products at the split-off point. Allocation based on the relative values of the products at the split-off point. Relative-Sales- Value Method Net-Realizable- Value Method Allocation based on final sales values less separable processing costs. Allocation based on a constant gross margin for all products. Gross margin Percent Method

13 Physical-Units Method
240,000 gallons 360,000 gallons Joint Production Process Split-Off Point Oil Gasoline Joint material cost = $275,000 Joint conversion cost = $225,000

14 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

15 Market-based Data Sales value at splitoff method
Estimated net realizable value (NRV) method Constant gross-margin percentage NRV method

16 Allocating Joint Costs Example
1,000 units of A at a selling price of P100 = P100,000 Joint processing cost is P200,000 1,500 units of B at a selling price of P300 = P450,000 2,000 units of C at a selling price of P200 = P400,00 Splitoff point

17 Allocating Joint Costs Example
A B C Total Sales Value P100,000 P450,000 P400,000 P950,000 Allocation of Joint Cost 100 ÷ ,053 450 ÷ ,737 400 ÷ ,210 200,000 Gross margin P 78,947 P355,263 P315,790 P750,000

18 Sales Value at Splitoff Method Example
Assume all of the units produced of B and C were sold. 250 units of A (25%) remain in inventory. What is the gross margin percentage of each product?

19 Sales Value at Splitoff Method Example
Product A Revenues: 750 units × P P75,000 Cost of goods sold: Joint product costs P21,053 Less ending inventory P21,053 × 25% , ,790 Gross margin P59,210

20 Sales Value at Splitoff Method Example
Product A: (P75,000 – P 15,790) ÷ 75,000 = 79% Product B: (P450,000 – P94,737) ÷ P450,000 = 79% Product C: (P400,000 – $84,210) ÷ P400,000 = 79%

21 Estimated Net Realizable Value (NRV) Method Example
Assume that MBA-TEP Company can process products A, B, and, C further into A1, B1, and C1. The new sales values after further processing are: A1: 1,000 × P120 = P120,000 B1: 1,500 × P330 = P495,000 C1: 2,000 × $210 = P420,000

22 Estimated Net Realizable Value (NRV) Method Example
Additional processing (separable) costs are as follows: A1: P35,000 B1: P50,000 C1: P55,000 What is the estimated net realizable value of each product at the splitoff point?

23 Estimated Net Realizable Value (NRV) Method Example
Product A1: P120,000 – P35,000 = P85,000 Product B1: P495,000 – P50,000 = P445,000 Product C1: P420,000 – P55,000 = P365,000 How much of the joint cost is allocated to each product?

24 Estimated Net Realizable Value (NRV) Method Example
To A1: 85,000 ÷ 895,000 × P200,000 = P18,994 To B1: 445,000 ÷ 895,000 × P200,000 = P99,441 To C1: 365,000 ÷ 895,000 × P200,000 = P81,564

25 Estimated Net Realizable Value (NRV) Method Example
Allocated Separable Inventory joint costs costs costs A1 P 18,994 P 35,000 P 53,994 B , , ,442 C , , ,564 Total P200,000 P140,000 P340,000

26 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.

27 Constant Gross-Margin Percentage NRV Method
Step 3: Deduct the expected separable costs from the total costs to obtain the joint-cost allocation.

28 Constant Gross-Margin Percentage NRV Method
What is the expected final sales value of total production during the accounting period? Product A1: P 120,000 Product B1: ,000 Product C1: ,000 Total P1,035,000

29 Constant Gross-Margin Percentage NRV Method
Step 1: Compute the overall gross-margin percentage. Expected final sales value P1,035,000 Deduct joint and separable costs ,000 Gross margin P695,000 Gross margin percentage: P695,000 ÷ P1,035,000 = 67.15%

30 Constant Gross-Margin Percentage NRV Method
Step 2: Deduct the gross margin. Sales Gross Cost of Value Margin Goods sold Product A1: P120,000 P 80,580 P 39,421 Product B1: 495, , ,608 Product C1: 420, , ,971 Total P 1,035,000 P695,000 P340,000

31 Constant Gross-Margin Percentage NRV Method
Step 3: Deduct separable costs. Cost of Separable Joint costs goods sold costs allocated Product A1: P 39,421 P 35,000 P 4,421 Product B1: 162, , ,608 Product C1: 137, , ,971 Total P340,000 P140,000 P200,000

32 Explain why the sales value at splitoff method is preferred
when allocating joint costs.

33 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.

34 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.

35 Avoiding Joint Cost Allocation
Some companies refrain from allocating joint costs and instead carry their inventories at estimated net realizable value.

36 Explain why joint costs sell-or-process-further decision.
are irrelevant in a sell-or-process-further decision.

37 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 price costs 1,000 A: P100 A1: P120 P35,000 1,500 B: P300 B1: P330 P50,000 2,000 C: P200 C1: P P55,000

38 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 P20,000 – Incremental cost P35,000 = (P15,000) Product B: Incremental revenue P45,000 – Incremental cost P50,000 = (P5,000) Product C: Incremental revenue $20,000 – Incremental cost P55,000= (P35,000)

39 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.

40 End of Report Thank you


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