Cost Allocation: Joint Products and Byproducts

1. Cost Allocation: Joint Productsand Byproducts Horngren, Foster & Datar Modified by Charles Bailey

2. Learning Objective 1 Identify the splitoff point(s) in a joint-cost situation.

3. Joint-Cost Basics Joint costs Joint products Byproduct Splitoff point Separable costs

4. Joint-Cost Basics Raw milk Cream Liquid Skim

5. Joint-Cost Basics Coal Gas Benzyl Tar

6. Learning Objective 2 Distinguish joint products from byproducts.

7. Joint Products and Byproducts Main Products Joint Products Byproducts High Low Sales Value

8. Learning Objective 3 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. Learning Objective 4 Allocate joint costs using four different methods.

11. Approaches to AllocatingJoint Costs Two basic ways to allocate joint costs to products are: Approach 1: Market based Approach 2: Physical measure

12. Approach 1: Market-based Data Sales value at splitoff method Estimated net realizable value (NRV) method We will not cover: Constant gross-margin percentage NRV method

13. Allocating Joint Costs Example 10,000 units of A at a selling price of $10 = $100,000 Joint processing cost is $200,000 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 Splitoff point

14. Allocating Joint Costs Example 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

15. Sales Value at SplitoffMethod Example Assume all of the units produced of B and C were sold. 2,500 units of A (25%) remain in inventory. What is the gross margin percentage of each product?

16. Sales Value at SplitoffMethod Example Product A Revenues: 7,500 units × $10.00 $75,000 Cost of goods sold: Joint product costs $31,008 Less ending inventory $31,008 × 25% 7,752 23,256 Gross margin $51,744

17. Sales Value at SplitoffMethod Example Product A: ($75,000 – $ 23,256) ÷ $75,000 = 69% Product B: ($315,000 – $97,674) ÷ $315,000 = 69% Product C: ($230,000 – $71,318) ÷ $230,000 = 69%

18. Estimated Net Realizable Value(NRV) Method Example Assume that Oklahoma 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

19. Estimated Net Realizable Value(NRV) Method Example Additional processing (separable) costs are as follows: B1: $46,500 C1: $51,500 A1: $35,000 What is the estimated net realizable value of each product at the splitoff point?

20. 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?

21. Estimated Net Realizable Value(NRV) Method Example To A1: 85 ÷ 575 × $200,000 = $29,565 To B1: 300 ÷ 575 × $200,000 = $104,348 To C1: 190 ÷ 575 × $200,000 = $66,087

22. Estimated Net Realizable Value(NRV) Method Example Allocated Separable Inventory joint costscostscosts 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

23. Approach 2: PhysicalMeasure Method Example $200,000 joint cost 20,000 pounds A 48,000 pounds B 12,000 pounds C (20/60)*$200K Product A $50,000 Product B $120,000 Product C $30,000

24. Learning Objective 5 Explain why the sales value at splitoff method is preferred when allocating joint costs.

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.

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.

27. Learning Objective 6 Joint costs are irrelevant in managerial decisions!

28. Irrelevance of Joint Costsfor 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 Unitspricepricecosts 10,000 A: $10 A1: $12 $35,000 10,500 B: $30 B1: $33 $46,500 11,500 C: $20 C1: $21 $51,500

29. Irrelevance of Joint Costsfor 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)

30. Learning Objective 7 Accounting for byproducts: A very brief overview omitting bookkeeping details.

31. Accounting for Byproducts The net sales value of a by product reduces the joint costs to be assigned to the joint or main product(s).

32. Joint-Cost Basics Coal each ton costs $50 Gas NRV=$100 Benzyl NRV=$80 Tar (byproduct) NRV=$10 Now the net joint costs to assign to Gas & Benzyl are ($50-10)=$40/ton

33. The End