Chapter 11

Allocation of Joint Costs and

Accounting for By-Products

Cost AccountingFoundations and Evolutions

Kinney, Prather, Raiborn

Learning Objectives (1of 1)

• Classify joint process outputs

• Identify when output becomes a joint product

• Allocate joint costs to products

• Describe how to handle by-products and scrap

Terms• Joint process - single process in which one

product cannot be manufactured without producing others– Extractive industries– Agriculture industries– Food industries– Chemical industries

TermsA joint process produces

(1) Joint products - primary outputs of a joint process; substantial revenue-generating ability

(2) By-products – incidental output of a joint process with a higher sales value than scrap but less than joint products

(3) Scrap –incidental output of a joint process with a low sales value

(4) Waste - residual output with no sales value

Terms• Joint costs – material, labor, and overhead

incurred during a joint process– Allocate to primary products of a joint process

using• Physical measures• Monetary measures

• Interpret costs allocated to joint products carefully; product profitability is determined largely by the allocation method

Problem

• Caster Company uses a joint process to produce two products-widgets and wonders. The joint cost was $400,000. The company produced 3,000 widgets and 5,000 wonders. Widgets sell for $50 per unit and wonders sell for $90 per unit. The cost to dispose of the widgets is $10 per unit and the cost to dispose of the wonders is $14 per unit.

Problem Continued

• 1. What is the joint cost allocated to widgets and wonders using the sales value at split-off method?

• 2. What is the joint cost allocated to widgets and wonders using the net realizable value method?

Terms• Split-off point - when joint products are first

identifiable as individual products

• At split-off, joint costs are allocated to joint products

Management Decisions

1. Will revenues exceed total costs?

2. What is the opportunity cost?

3. How to classify outputs?

4. Sell at split-off or process further?

To Process or Not to Process?

Two Ways to Allocate Joint Costs

1. Physical measure– Common physical characteristic

2. Monetary measure

Each method may allocate

a different cost to joint products

Allocating Joint Costs

• Physical Measure– Tons of meat, bone and hide– Linear board feet in lumber milling– Barrels of oil in petroleum refining– Number of computer chips in semiconductors– Use for products with unstable selling prices

Allocating Joint Costs

Monetary Measure Choices– Sales value at split-off– Net realizable value at split-off– Approximated net realizable value

at split-off

Problems

• Parker Company uses a joint process to produce two chemicals---AC22 and SD14. The company produced 10,000 gallons of AC22 and 30,000 gallons of SD14. AC22 sells for $10 per gallon, and SD14 sells for $12 per gallon. The joint cost was $80,000. Compute the joint cost allocated to each product using physical measure allocation.

Problems• Pillow Company produces two chemicals---

XB57 and JG42. The joint cost was $1,200,000. The company produced 20,000 barrels of XB57 and 25,000 barrels of JG42. Product XB57 sells for $40 per barrel, and Product JG42 sells for $48 per barrel. The cost to dispose of XB57 is $8 per barrel and the cost to dispose of JG42 is $14 per barrel. Compute sales value at split-off and net realizable value method.

Monetary Measure Allocation

• Approximated net realizable value at split-off– Assumes that incremental revenue from

further processing is equal to or greater than the incremental costs of further processing and selling

Problem• Collins Company produces X59 and Z47.

The company produced 10,000 units of X59 and 8,000 units of Z47. Product X59 sells for $86 per unit after further processing costs of $6 per unit and disposal costs of $20 per unit. Product Z47 at the split-off point sells for $50 per unit and disposal costs are $10 per unity. The joint cost was $640,000. Compute the joint cost allocated to each product using the approximated net realizable value method.

Joints Costs Service Organizations

• Joint costs include– Advertising for multiple products

– Printing for multipurpose documents

– Events held for multiple purposes

• Not required to allocate joint costs• Allocation base

– Physical (number of locations)

– Monetary (sales volume)

Accounting for By-Products and Scrap

By-products, scrap, and waste may provide substantial revenue

Companies are devoting time, attention, and creativity to

developing innovative revenue sources from by-products, scrap,

and waste

Accounting for By-Products and Scrap• Sales value of by-products/scrap is

recorded using– Net Realizable Value Method or– Realized Value Method

• Choose method based on– magnitude of net realizable value – need for additional processing after split-off

Net Realizable ValueBy-Products and Scrap

• Indirect method– Net realizable value reduces cost of goods sold

for joint products• Conservative; joint cost is reduced when the

product/scrap is sold

• Direct method– Net realizable value reduces work in process

for joint products• Joint cost is reduced when by-product/scrap is

produced

Net Realizable Value (NRV)By-Products and Scrap

• NRV is the traditional method, not necessarily best method

• By-products have either no assignable costs or costs equal to their net sales value

• Difficult for management to – monitor production and further processing of

by-products– make effective decisions for by-products

Realized ValueBy-Products and Scrap

• By-product/scrap value is recognized when items sold

• First option– Proceeds recorded as Other Revenue– Costs of additional processing or disposal added to

costs of primary products– Provides little information to management as it

does not match revenues and expenses

Realized ValueBy-Products and Scrap

• By-product/scrap value is recognized when items sold

• Second option– Proceeds less related costs shown as Other Income– Matches revenues and related expenses for storage,

further processing, transportation, and disposal costs– Highlights the revenue enhancement provided by

managing the costs and revenues related to by-products/scrap

– Allows for better control and improved performance

Realized ValueBy-Products and Scrap

• Other Options (clerically efficient )– Proceeds added to gross margin– Proceeds reduce cost of goods manufactured– Proceeds reduce cost of goods sold

Job Order CostingBy-Products or Scrap

• Use net realizable value or realized value approach

• If most jobs create by-products or scrap– Proceeds reduce the manufacturing overhead

account– The journal entry using the realized value

approach is:

Cash

Manufacturing Overhead

Job Order CostingBy-Products or Scrap

• If only specific jobs create by-products or scrap– Proceeds reduce work in process for the specific

job– The journal entries using the net realizable value

approach are:

Scrap Inventory

Work in Process

Cash

Scrap Inventory

Joint Costs Not-For-Profit Organizations

• Joint costs related to– fundraising– accomplishing an organizational program– conducting an administrative function

• Joint costs must be allocated

• Clearly show the amount spent for various activities - especially fundraisers