1. © www.paperhint.com 14-1 Process, Joint and BY- Product Costing

2. © www.paperhint.com 14-2 Process Accounting Process costing system measures the cost of products under conditions of continuous production, sequential processing and homogeneous output. The procedure under such a system of costing essentially involves averaging the total costs of a process or a department. It is used in industries such as chemicals, food processing, breweries, petroleum refining, paper, glass, metal manufacturing and so on. Process costing assumed a sequential flow of cost from one process to another as unit of output pass through a number of specified production processes.

3. © www.paperhint.com 14-3 COST ACCUMULATION IN PROCESS COSTING The procedure to determine the cost will depend on, firstly, the stage of completion of the product, in each process, secondly, the extent of wastage, spoilage of units in the process and, thirdly, the inter-process profits. In cases where some units are complete, while others are incomplete or partially complete, for the purpose of cost accumulation, the partially completed units are to be converted into comparable equivalent units. Equivalent units = [Actual number of partially completed units × Stage of completion]

4. © www.paperhint.com 14-4 Completed Units Example 1: A product passes through two processes, A and B. During the month ended June 30, 1,500 units were produced. The detailed cost break-up is as follows: Process AProcess B Direct materials Direct labour Direct expenses Rs 90,000 75,000 15,000 Rs 75,000 1,50,000 18,000 Indirect overhead costs during the period were Rs 60,000 apportioned to the processes on the basis of direct labour cost. No work-in-progress existed at the beginning and end of the period. Prepare relevant process accounts.

5. © www.paperhint.com 14-5 Solution Process A Account To direct materials To direct labour To direct expenses To indirect overheads (Rs 60,000 × 1/3) Rs 90,000 75,000 15,000 20,000 2,00,000 By Cost of output transferred to process B Rs 2,00,000 ________ 2,00,000 Process B Account To process A (cost transferred) To direct material To direct labour To direct expenses To indirect overheads (Rs 60,000 × 2/3) Rs 2,00,000 75,000 1,50,000 18,000 40,000 4,83,000 By cost of output transferred to finished goods inventory Rs 4,83,000 ________ 4,83,000 Finished Goods Inventory To process B (cost of output)4,83,000

6. © www.paperhint.com 14-6 Example 2 From the following information of ABC Manufacturers Limited, prepare a statement of equivalent units. Opening inventory: Partially completed units (40 per cent complete) Units introduced during the period Closing inventory (partially completed units: 70 per cent complete) 600 10,000 2,000 Solution Statement of Equivalent Units 1.Work necessary to complete opening inventory (600 × 0.60) 2.Work necessary to start and finish units introduced during the current year (10,000 – 2,000 partially completed units) 3.Work performed on closing inventory (2,000 × 0.70) Total number of equivalent units 360 8,000 1,400 9,760

7. © www.paperhint.com 14-7 Example 3 From the following production record of XYZ Manufacturing Company Ltd, prepare a statement of equivalent units: Units in process-opening2,000 Stage of completion (%):material100 labour60 overheads50 New units introduced20,000 Units completed18,000 Units in process-closing4,000 Stage of completion (%):material100 labour50 overheads40

8. © www.paperhint.com 14-8 Solution Table 1 Statement of Equivalent Units InputParticularsNumber of units (comple ted or otherwi se) Work performed during the current period [stage of completion (per cent)] Equivalent produced units: input units× stage completion in respect of Mate rial Lab our Over- heads Materia l LabourOver- heads Opening inventory 2,000 units + 20,000 units introduced during the current period _____ 22,000 Work expended on opening inventories (100 per cent stage of completion) Units started and completed during the current period (18,000 total units completed inventory) Closing inventory (work-in-process) 2,000 16,000 4,000 22,000 Nil 100 40 100 50 100 40 — 16,000 4,000 20,000 800 16,000 2,000 18,800 1,000 16,000 1,600 18,600

9. © www.paperhint.com 14-9 Process Accounts/Production Cost Report The cost of production is shown in the form of a production cost report and/or process cost account. The total cost of production of each process is split into the cost of output and the closing inventory /work-in-process. The distribution between these two elements depends on the method of valuation of work-in-process, namely, (i)weighted average method and (ii) first-in-first-out (FIFO) method.

10. © www.paperhint.com 14-10 Weighted Average Cost Method Under this method, total costs in process are divided by equivalent units produced by the process to ascertain the cost per equivalent unit. Exhibit 1: Process Account (Weighted Average Cost Method). ToWork-in-process (opening inventory) To Current costs Material Labour Overheads To Closing work-in-process inventory to be carried to the next period By Cost of completed units transferred to next process/finished goods inventory A/c By Closing work-in-process

11. © www.paperhint.com 14-11 FIFO Method Unlike the weighted average cost method, this method is based on the assumption that units in process at the beginning of the period are the first to be completed and accordingly the first costs incurred in the current period should be attached to the units of the opening work-in-process inventory. Exhibit 2: Process Account (FIFO Method) To Work-in-process opening inventory during the current period (units partially completed in earlier period) To Current costs 1.To complete opening inventory units 2.To work initiated on new units in the current period in this process: (a)Some of which are completed and transferred (b)Some of which are not yet completed and carried as opening inventory for next period To Closing work-in-process inventory to be carried forward to the next period By units completed 1.Units started in earlier period and completed during the current period 2.Units started and completed duringthe current period 3.Units started but not completed during the current period

12. © www.paperhint.com 14-12 Example 4 For the firm in Example 3, assume the following: Cost of 2,000 units in process (opening): Materials Labour Overheads Processing costs during the current period Materials Labour Overheads Rs 6,000 3,600 2,400 69,900 56,560 58,360 Prepare a cost of production report for the current period using (a) weighted average, and (b) FIFO costing methods.

13. © www.paperhint.com 14-13 Solution Cost of Production Report of Process A (Weighted average cost method) Flow of completed or partially completed units: Opening2,000 Introduced20,000 Total in process22,000 Less completed18,000 In process4,000 Equivalent units in process: Conversion costs MaterialLabourOverhead Units completed18,000 Equivalent units in ending inventory4,0002,0001,600 22,00020,00019,600

14. © www.paperhint.com 14-14 Total cost to be accounted for: MaterialLabourOverhead s Total Work-in-process (opening)Rs 6,000Rs 3,600Rs 2,400Rs 12,000 Current costs69,90056,56058,3601,84,820 Total cost in process75,90060,16060,7601,96,820 Equivalent units (EU) in process22,00020,00019,600— Cost per equivalent unit in process (Total cost ÷ EU)3.453.0083.19.558 Costs accounted for: Transferred to finished goods inventory (18,000× Rs 9.558)1,72,044 Work-in-process (closing inventory) Materials (4,000× 100 per cent× Rs 3.45)Rs 13,800 Labour (4,000× 0.50× Rs 3.008)6,016 Overheads (4,000× 0.40× Rs 3.1)4,96024,776 Total costs accounted for1,96,820 (Contd.)

15. © www.paperhint.com 14-15 Cost of Production Report of Process A (FIFO method) Flow of completed or partially completed units: Opening2,000 Introduced20,000 Total in process22,000 Less completed18,000 In process4,000 Equivalent units manufactured: Conversion costs MaterialLabourOverheads Units completed18,000 Equivalent units in ending inventory 4,0002,0001,600 Equivalent units in process22,00020,00019,600 Less equivalent units in opening inventory 2,0001,2001,000 Equivalent units manufactured20,00018,80018,600

16. © www.paperhint.com 14-16 Total costs to account for: MaterialLabourOverhead s Total Opening work-in- process ———Rs 12,000 Current costsRs 69,900Rs 56,560Rs 58,3601,84,820 Total costs in process1,96,820 Equivalent units manufactured 20,00018,80018,600— Cost per equivalent unit manufactured 3.4953.0085 3.13769.6411 Costs accounted for: Transferred to finished goods inventory (Contd.)

17. © www.paperhint.com 14-17 First batch: Work-in-process opening inventory Rs 12,000 Add conversion costs: Labour (2,000× 0.40× Rs 3.0085) 2,406.8 Overheads (2,000× 0.50× Rs 3.1376) 3,137.6Rs 17,544.4 Second batch: Started and completed (16,000× Rs 9.6411)1,54,257.6 Work-in-process (closing): Materials (4,000× 100 per cent× Rs 3.495)13,980 Labour (4,000× 0.50× Rs 3.0085) 6,017 Overheads (4,000× 0.40× Rs 3.1376) 5,020.1625,017.16 1,96,819.16

18. © www.paperhint.com 14-18 Comparison For comparison of the two costing methods, summary results of important items are listed below: FIFOWeighted average cost (A)Cost of output transferred from (i) Opening inventoryRs 17,544.40Rs 1,72,044 (ii) Current production1,54,257.60Rs 1,71,802 (B)Closing work-in-process25,017.1624,776 1,96,819.161,96,820

19. © www.paperhint.com 14-19 Spoilage The spoilage of units under process costing may take place due to a variety of reasons, like use of sub-standard material, poor workmanship, evaporation, shrinkage, break-down of machines, and so on. The effect of spoilage is that the number of actual units produced is less than the units introduced initially. The spoilage or wastage may be normal or abnormal. The unit cost with normal spoilage. = Total process costs – Salvage value of normal spoilage Total units introduced – Normal loss in units Abnormal Loss Abnormal loss = [(Abnormal loss in units × Unit production cost) – Salvage value of abnormal spoilage] Inter-Process Profits Inter-process profit is the profit arising out of transfer of the product of one process to the other on the basis of market/inflated price.

20. © www.paperhint.com 14-20 Example 5 Six hundred kgs of material was charged to process I at the rate of Rs 4 per kg. The direct labour accounted for Rs 200 and the other departmental expenses amounted to Rs 760. The normal loss is 10 per cent of input. During the period, the actual production was 500 kgs and 100 kgs was scrap. Assuming that the scrap is saleable at Rs 2 per kg, prepare a ledger account of process I, showing the values of normal and abnormal losses. Solution Process I Account ParticularsUnits (kgs) AmountParticularsUnits (kgs) Amount To materials600Rs 2,400By normal loss (600× 0.10) 60Rs 120 To wages200By abnormal loss40240 To departmental expenses760 By process II (500 units transferred at Rs 6 each)5003,000 6003,3606003,360

21. © www.paperhint.com 14-21 Working Notes Cost per unit = (Rs 3,360 - Rs 120)/ 540 units = Rs 6 Amount of abnormal loss Units introduced600 Less normal loss (10 per cent) 60 Normal output expected540 Less actual output achieved500 Abnormal loss (units)40 (×) Cost per unitRs 6 Total loss240 Less sale value of scrap (40× Rs 2) 80 Total160

22. © www.paperhint.com 14-22 Inter-Process Profit Example 6 (Inter-Process Profits) A product passes through three processes, A, B, and C. The output of process A and B is charged to the next process at a price calculated to give a profit of 16.67 per cent on transfer price while the output of process C is charged to the finished stock account at a profit of 13.33 per cent on the transfer price. From the following particulars, prepare the process cost accounts and calculate the amount of reserve that should be made in respect of the stock in hand. Process AProcess BProcess C Materials and labourRs 7,000Rs 2,800Rs 4,800 Closing stock2,0002,8002,000 There was no stock in hand at the beginning of the period. The closing stocks are valued at prime cost in each process.

23. © www.paperhint.com 14-23 Solution Process A Account ParticularsAmountParticularsAmount To materials and labourRs 7,000By closing stockRs 2,000 To profit (Rs 6,000 × 0.1667)1,000 By process B (Rs 5,000 × 120/100)6,000 8,000 Process B Account ParticularsAmountParticularsAmount To process ARs 6,000By closing stockRs 2,800 To material and labour2,800By process C (Rs 6,000 × 120/100) 7,200 To profit (Rs 7,200 × 0.1667) 1,200________ 10,000

24. © www.paperhint.com 14-24 Process C Account ParticularsAmountParticularsAmount To process BRs 7,200By closing stockRs 2,000 To materials and labour4,800By finished goods (10,000 × 115.38/100) 11,538 To profit (Rs 11,538 × 0.1333)1,538 ______ 13,538

25. © www.paperhint.com 14-25 Working Notes 1Profit of 16.67 per cent on transfer means 20 per cent on cost price. 2Likewise, profit of 13.33 per cent on transfer price means 15.38 per cent on cost. 3Provision for unrealised profit: Process A: Nil Process B: (Rs 1,000 × 2,800)/8,800 = Rs 318 Process C: Closing stock of process C of Rs 2,000 is made up of respective cost proportions of C: B, that is, 2:3 (Rs 4,800: Rs 7,200).

26. © www.paperhint.com 14-26 Statement of Profit Process ARs 1,000 Process BRs 1,200 Less provision for unrealised profit318882 Process C1,538 Less provision for unrealised profit3131,225 Profit realised3,107 Process C’s share is = Rs 2,000 × 2/5 = Rs 800 Process B’s share is = Rs 2,000 × 3/5 = Rs 1,200 Profit included in Rs 1,200 (process B’s cost) is = Rs 1200 × 20/120 = Rs 200 (i) Profit included in Rs 1,000. This includes part of process A’s costs: Rs 1,000 × 60/88= Rs 682. Rs 682 includes profit element of = Rs 682 × 20/120 = Rs 113(ii) Total profit included in process C = Rs 313 (200 + 113)(i + ii)

27. © www.paperhint.com 14-27 Alternatively Process A Account ParticularsTotal (Rs) Cost (Rs) Profi t (Rs) ParticularsTotal (Rs) Cost (Rs) Profit (Rs) To materials and labour 7,000 —By closing stock 2,000 — To profit (Rs 5,000 × (50/3) × (3/250)1,000— By process B (transferred)6,0005,0001,000 8,0007,0001,0008,0007,0001,000

28. © www.paperhint.com 14-28 Process B Account Total (Rs) Cost (Rs) Profit (Rs) Total (Rs) Cost (Rs) Profit (Rs) To process A6,0005,0001,000By Closing stock (2,800 × 1,000) ÷8,800 2,8002,482318 To materials and labour 2,800 —By process C (transferred) 7,2005,3181,882 To profit and loss A/c (Rs 6,000 × (50 × 3) ÷ (3 × 250))1,200— 10,0007,8002,20010,0007,8002,200

29. © www.paperhint.com 14-29 Process C Account To process B Rs 7,200Rs 5,318Rs 1,882By closing stock Rs 2,000Rs 1,687Rs 313 To materials and labour 4,800 —By finished goods A/c (at 115.38 per cent of cost) 11,5388,4313,107 To profit and loss A/c (0.1333 × Rs 11,538)1,538— 13,53810,1183,42013,53810,1183,420

30. © www.paperhint.com 14-30 Joint Products Two or more products produced simultaneously from a common set of inputs through a single manufacturing (joint) process are called joint products. The joint products can be sold either at the stage of production (split-off point) itself or they can be processed further. Split-off Point Split-off point is that stage in the manufacturing process where joint products are separately identifiable. The costs incurred before the split-off point are called joint/common/inseparable costs and the costs incurred beyond that point are known as separable costs. The crucial factor in accounting for joint products is the allocation of joint costs among the joint/multiple products from the joint process.

31. © www.paperhint.com 14-31 Allocation of Joint Costs (1) Physical Quantities Method/Unit Method (2) Relative Sales Value/Net Realisable Value (NRV) Method (3) Net Realisable Value Less Normal Profit Method (4) Weighted Average Method The commonly used methods of allocating joint process costs are:

32. © www.paperhint.com 14-32 Example 7. (Allocation of Joint Costs Under Unit Method) Royal Industries Ltd manufactures products X, Y and Z by processing a specific raw material in Department 1. The production process is such that every 1,100 kgs of raw materials that is put into Department 1 yields 400 kgs of X, 250 kgs of Y and 350 kgs of Z. The total cost of processing a batch of 1,100 kgs of raw materials through Department 1 is Rs 22,000. Allocate the joint costs to the three products using the physical quantity method. Solution Joint Cost Allocation Using Unit Method ProductOutput (kgs)Rates (per cent)Allocated joint cost Cost per unit XYZXYZ 400 250 350 1,000 40 25 35 100 Rs 8,800 5,500 7,700 22,000 Rs 22 22 Physical Quantities Method/Unit Method Under the physical quantities method, the total joint costs are allocated to the joint products in proportion to the physical measurement of output.

33. © www.paperhint.com 14-33 This method results in identical unit costs for each product. Identical benefits exist only if the products are homogeneous. It will, therefore, provide a satisfactory basis of allocating joint cost if the different products are homogeneous and their sale prices are relatively close to each other. Otherwise, it may lead to misleading results in that there will be wide divergence in the gross margin of the different products as shown in Table 2. Table 2 Gross Margin of Different Products Product XProduct YProduct Z Sales priceRs 33Rs 44Rs 66 Less cost of production 22 Cross margin112244 Gross margin percentage33.335066.67

34. © www.paperhint.com 14-34 Relative Sales Value/Net Realisable Value (NRV) Method In the net realisable value method, joint costs are pro-rated on the basis of the market value of the joint products. From the facts in Example 7 and Table 2 and assuming all products are sold at the split-off point, joint cost allocation under the relative sale value method would be, as shown in Table 3. Table 3 Joint Cost Allocation Using Sales Value Method ProductOutput (kgs) Market price Market value RatesAllocated joint cost Cost per unit X400Rs 33Rs 13,200132/473Rs 6,140Rs 15.35 Y2504411,000110/4735,11620.46 Z3506623,100231/47310,74430.70 1,00047,30022,00022.00 Thus, the costs per unit are in proportion to the sale prices. The relative sale price method generates the same margin percentage (53.48 per cent) for all products. Thus, this approach implies a matching of input costs with revenues generated by each output.

35. © www.paperhint.com 14-35 Assuming that for the firm in Example 7, the additional processing for products X, Y and Z is done in departments 2, 3 and 4 respectively. Following are the costs incurred in these departments to process the batch of 1,100 kgs of materials: ProductOutput (kgs)Department Further processing/ separable cost Unit cost X4002Rs 6,000Rs 15 Y25034,50018 Z35047,00020

36. © www.paperhint.com 14-36 Assuming no change in market price, joint costs of Royal Industries Ltd would be allocated as shown in Table 4. Table 4 Allocation of Joint Costs [Net Realisable Value (NRV) Method] Product Output (kgs) Market price Market value Separab le cost Net realisable value Rat es Allocated joint costs Joint cost per unit X400Rs 33Rs 13,200Rs 6,000Rs 7,200 72/2 98 Rs 5,315Rs 13.28 Y2504411,0004,5006,500 65/2 98 4,79919.19 Z3506623,1007,00016,100 161/ 298 11,88633.96 1,00047,30017,50029,80022,00022.00

37. © www.paperhint.com 14-37 The gross margin rates for each product according to this method are shown in Table 5. Table 5 Gross Margin Rates Product XProduct YProduct Z Sales priceRs 33.00Rs 44.00Rs 66.00 Less cost of production: Joint cost13.2819.1933.96 Separable cost15.0018.0020.00 28.2837.1953.96 Gross margin4.726.8112.04 Gross margin rate (percentage)14.315.518.21

38. © www.paperhint.com 14-38 Net Realisable Value Less Normal Profit Method The net realisable value less normal profit method differs from the net realisable value method to the extent the joint costs less normal profits are pro-rated. Table 6 Joint Cost Allocation Using NRV Less Normal Profit Method ProductOutput (kgs) Market value Normal profit Separabl e costs Joint cost allocatio n Joint cost per unit X400Rs 13,200Rs 2,177Rs 6,000Rs 5,023Rs 12.557 Y25011,0001,8144,5004,68622.744 Z35023,1003,8097,00012,29135.117 1,00047,3007,80017,50022,000 Working Notes Normal profit ratio = 100 per cent – [Total costs – (Joint + Separable)× 100] ÷ Total market value = 100 per cent – [(Rs 22,000 + Rs 17,500)× 100 ÷ Rs 47,300, 83.5 per cent = 16.5 per cent]

39. © www.paperhint.com 14-39 Weighted Average Method Where the joint products are heterogeneous, the weighted average cost method provides a reasonable basis for allocating the joint costs. Continuing with the example of Royal Industries Ltd, assume that the following are the weights assigned to products X, Y and Z after taking into consideration a variety of factors: X, 1; Y, 2; Z, 4. Using the weighted average method, the joint costs are allocated in Table 7. Table 7 Joint Cost Allocation Using Weighted Average Method ProductOutput (kgs) WeightWeighte d output RatioAllocated joint cost Cost per unit X4001 4/23Rs 3,826Rs 9.56 Y25025005/234,78319.13 Z350 41,40014/2313,39138.26 1,0002,30022,000

40. © www.paperhint.com 14-40 By-Products A by-product is incidental to the process of manufacturing the main/joint product. The accounting treatment depends on whether the by-product is sold at the split-off point or is processed further. The two most commonly-used methods of accounting for by- products are: (1) Miscellaneous income method (ii) Net realisable value method, (NRV) Recognisation of No Profit on the Sale of By-products Recognisation of Some Normal Profit on the Sale of By-products

41. © www.paperhint.com 14-41 (i) Miscellaneous Income Method Under the miscellaneous income method, the income generated by the by-products is treated as a miscellaneous income and all the associated costs are charged to the main product. (ii) Net Realisable Value Method, (NRV). According to the NRV method, the by-product is valued at its net realisable value and the joint costs are pro-rated between the main product and the by-product. Joint process cost allocated to by-product = (Sale price of by-products – Selling and distribution costs of by-products). A variation of this is to recognise some normal profit from the sale of by-products. Joint cost allocated to by-products = (Sale price of by- products – Normal profit – Selling and distribution costs of by- product).

42. © www.paperhint.com 14-42 Example 8 For the facts contained in Example 7, let as assume further that joint production process also yields by-product (70 kgs) in addition to three main products X, Y, Z. Its selling price is Rs 2 per kg and selling costs are Rs 0.50 per kg. Determine the share of joint costs (i) if firm does not recognize profit on the sale of its by-product; and (ii) if it recognizes 10 per cent profit on such sales. Solution Share of Joint Costs (i)When no profits are recognized: Sales revenue (70 kgs × Rs 2) Less selling costs (70 kgs × Rs. 0.50) Share of joint costs (70 kgs × Rs 1.50) (ii)When 10 per cent profits are recognised: Sales revenue (70 kgs × Rs 2) Less normal profit (Rs 140 × 0.10) Less selling costs (70 kgs × Rs 0.50) Share of joint costs (70 kgs × Rs 1.30) Rs 140 35 105 140 14 35 91

43. © www.paperhint.com 14-43 SELL NOW (AT SPLIT-OFF POINT) OR PROCESS FURTHER

44. © www.paperhint.com 14-44 Example 9 (Sell Now or Process Further: Single Product) A B C Ltd manufactures a single product which it sells to firms which process it further before sale. The normal quarterly operating volume for the company is 50,000 units produced and sold. The relevant cost data are as follows: Selling priceRs 10.00 Less standard costs: Direct materialsRs 3.00 Direct labour1.50 Variable manufacturing overheads1.00 Fixed manufacturing overheads (Rs 25,000 per quarter)0.50 Variable selling overheads1.00 Fixed selling expenses (Rs 12,500 per quarter)0.257.25 Standard profit per unit2.75

45. © www.paperhint.com 14-45 The company’s management is considering the possibility of further processing the product and selling it directly to the customers. The management estimates that the product can be sold @ Rs 14 per unit after further processing. The following are the estimates of the additional (per unit/ quarter) costs of processing 50,000 units: Direct labourRs 1.00 Variable manufacturing overheads0.50 Variable selling costs0.20 Additional fixed manufacturing overheads (per quarter)10,000 Additional sales expenses (per quarter)5,000 You are required to compute the cost (i) without, and (ii) with further processing. Is further processing advisable?

46. © www.paperhint.com 14-46 Solution Cost Comparison: Incremental Analysis ParticularsWithout further processing With further processingDifference from further processing Per unitTotalPer unitTotalPer unitTotal Sales Less variables costs: Direct material Direct labour Manufacturing overheads Selling overheads Total Contribution Less separable identifiable fixed costs: Manufacturing Sales Product margin Less common fixed costs: Manufacturing Sales Net income Rs 10.00 3.00 1.50 1.00 6.50 3.50 Rs 5,00,000 1,50,000 75,000 50,000 3,25,000 1,75,000 — 1,75,000 25,000 12,500 1,37,500 Rs 14.00 3.00 2.50 1.50 1.20 8.20 5.80 Rs 7,00,000 1,50,000 1,25,000 75,000 60,000 4,10,000 2,90,000 10,000 5,000 2,75,000 25,000 12,500 2,37,500 Rs 4.00 0.00 1.00 0.50 0.20 1.70 2.30 Rs 2,00,000 50,000 25,000 10,000 85,000 1,15,000 10,000 5,000 1,00,000 — 1,00,000 Since further processing would result in a greater product margin and net income, the new proposal is acceptable.

47. © www.paperhint.com 14-47 Example 10 (Sell or Process Further: Multiple Products) XYZ Ltd produces three products, A, B and C. One type of a raw material is used for all these products. Raw material enters the process in department 1 of the factory. Department 1 separates material for products A, B and C. During the last quarter, Rs 4,00,000 of material was issued to Department 1. Other direct costs of operating Department 1 were Rs 2,00,000. The output of products A, B and C from Department 1 was: A, 10,000 units; B, 5,000 units; C, 2,000 units. Products A, B and C can be sold after being processed from Department 1 (split-off point) at prices of Rs 60, Rs 30 and Rs 20 respectively. After the split off, product A could be processed further in Department 2. With additional processing, product A can be sold at Rs 70 per unit. After the split-off, product B could be processed further in Department 3 for Rs 30,000 additional cost, and will fetch Rs 35 per unit after processing. Product C is not suitable for further processing and has to be sold at the point of split-off. What action should be management take?

48. © www.paperhint.com 14-48 Solution Sell or Process Further: Decision Analysis ParticularsProduct AProduct B Sell nowProcess further Difference from further processing Sell nowProcess further Differenc es from further Processi ng Sales Less separable costs Joint cost of Rs 6,00,000 from Department 1 Rs 6,00,000 — Rs 7,00,000 50,000 Rs 1,00,000 50,000 Rs 1,50,000 — Rs 1,75,000 30,000 Rs 25,000 30,000 Irrelevant as costs not affected by the decision Contribution (decrease) Rs 6,00,0006,50,00050,0001,50,0001,45,000(5,000) Thus, it is profitable to process product A further because it yields an incremental profit of Rs 50,000, (additional revenue being Rs 1,00,000 and additional cost, Rs 50,000). The decision is based on the assumption that there is no other opportunity cost for using the facilities of Departments 2 and 3.

49. © www.paperhint.com 14-49 By-Product Processed Further There are several methods of accounting for costs of further processing: (1) Recognition of No Profit on Sale of By-products Method Under this method, share of joint costs allocated to by-products would be determined by subtracting both selling and further processing costs from the sale price of by-products. Sale price of by-products – Further processing cost beyond split-off point – Selling cost = Joint costs. (2) Recognition of Normal Profit on Sale of By-Products/Reversal Cost Method Under this method, by-products are valued at the price which would have been paid by the firm in making outside purchases for these products. (3) Separate Cost Record for By-products This method is most appropriate in situations when the joint manufacturing process yields by-products which are relatively of high value and/or of large quantity; they also require further processing after separation from the joint manufacturing process.

50. © www.paperhint.com 14-50 Example 11 (Reversal Cost Method) In manufacturing the main product, Hypothetical Ltd processes the incidental waste into two products, A and B. From the following data relating to the products, you are required to prepare a comparative profit and loss statement showing the individual costs and other details. The total costs upto separation point were Rs 3,10,400. Main productBy-product ABy-product B SalesRs 8,00,000Rs 64,000Rs 96,000 Costs after separation80,00012,80014,400 Estimated net profit (per cent to sales value) 2030 Estimated selling expenses (as per cent to sales value) 201015

51. © www.paperhint.com 14-51 Solution Statement Showing Allocation of Joint Costs ParticularsBy-product ABy-product B SalesRs 64,000Rs 96,000 Less: estimated net profit on sale (20 per cent, A; and 30 per cent, B)12,80028,800 estimated selling expenses (10 per cent, A, and 15 per cent, B)6,40014,400 separable costs12,80014,400 Share of joint costs allocated32,00038,400 Share of main products in joint costs, therefore, would be: Rs 3,10,400 – (Rs 32,000 + Rs 38,400) =Rs 2,40,000.

52. © www.paperhint.com 14-52 Comparative Profit and Loss Account ParticularsMain productBy-product ABy-product B Sales revenueRs 8,00,000Rs 64,000Rs 96,000 Less cost of production: Joints costs2,40,00032,00038,400 Separable costs80,00012,80014,400 Gross profit4,80,00019,20043,200 Less selling expenses1,60,0006,40014,400 Net profit3,20,00012,80028,800