Learning Objective #4 Effect of Joint Product Costs on Cost Control and Decision Making Joint product costing may affect cost control and decision making in the following areas: out- put decisions, further processing of joint products, and pricing jointly produced products. ‘A. Output Decisions 41. Output decisions are normally based on the comparison of total cost of the joint prod- ucts and the combined sales revenues for measuring profitability at any given point. 2. If management cannot change the product mix or the product mix is determined by customer demand, cost allocation is useless for output decisions because the en- tire package has to be produced B. Further Processing Decisions 1. In making decisions on whether to sell a joint product at split-off or to process it further, only the costs and revenues incurred after the split-off point are pertinent. 2, Joint costs include those costs incurred prior to the split-off point and, thus, are Considered sunk costs with respect to further processing decisions (that is, the joint cost is not a relevant cost). C. Pricing Joint Products Methods used to set joint product prices include: 1. Sales or market price method a. This method maintains a constant relationship of cost to market prices, but it cannot be used to set prices since price has to be known in order to determine cost. b. The method is circular but useful in limited situations. = Example: The meat-packing industry uses the market value of by- products as an important determinant of the main product's price. = Example: The natural gas industry uses it to justify prices and exist- ing price relationships to regulatory bodies. Joint cost allocation is used to determine inventory values, not as a basis to determine a cost to be used in price regulation, 2. Historical market differentials between products method When market differentials are stable over time, this method provides a guide to pric- ing individual products by giving figures comparable to those of competitors. D. Pricing Based on Cost of Further Production This method differs from the benefits-received approaches because it does not assign average cost based on physical or weighted units. Its different from the relative mar- ket value because the joint product itself does not have a market value. = Example: The practice of organ transplant sets the costs of the jointly available organs based on the eventual cost of the subsequent transplant opera- tion, Joint Production of Services = Leaming Objective #5 Normally services do not yield a true joint output because a service can be directed to one effect rather than to two effects simultaneously. Joint cost allocation issues with services usually relate to pricing problems. = Example: An insurance company may allow only a portion of a massage therapy charge to be allocated to the therapeutic aspect. = Example: The IRS might allow the cost of a two-day seminar as a deductible business expense. But if the seminar were offered on a cruise ship and spread out over a five- day period, the IRS would look closely if claimed as a deduction and not separated from the overall cost of the cruise.2. If management cannot change the product mix or the product mix is determined by customer demand, cost allocation is useless for output decisions because the en- tire package has to be produced B. Further Processing Decisions 1. In making decisions on whether to sell a joint product at split-off or to process it further, only the costs and revenues incurred after the split-off point are pertinent. 2. Joint costs include those costs incurred prior to the split-off point and, thus, are considered sunk costs with respect to further processing decisions (that is, the joint cost is not a relevant cost), CC. Pricing Joint Products Methods used to set joint product prices include: 1, Sales or market price method a. This method maintains a constant relationship of cost to market prices, but it cannot be used to set prices since price has to be known in order to determine cost. b. The method is circular but useful in limited situations. = Example: The meat-packing industry uses the market value of by- products as an important determinant of the main product's price. =~ Example: The natural gas industry uses it to justify prices and exist- ing price relationships to regulatory bodies. Joint cost allocation is used to determine inventory values, not as a basis to determine a cost to be used in price regulation, 2. Historical market differentials between products method When market differentials are stable over time, this method provides @ guide to pric- ing individual products by giving figures comparable to those of competitors. D. Pricing Based on Cost of Further Production This method differs from the benefits-received approaches because it does not assign average cost based on physical or weighted unis. It is different from the relative mar- ket value because the joint product itself does not have a market value. = Example: The practice of organ transplant sets the costs of the jointly available organs based on the eventual cost of the subsequent transplant opera- tion, Joint Produc n of Services | Leaming Objective #5 Normally services do not yield a true joint output because a service can be directed to one effect rather than to two effects simultaneously. Joint cost allocation issues with services usually relate to pricing problems. = Example: An insurance company may allow only a portion of a massage therapy charge to be allocated to the therapeutic aspect. = Example: The IRS might allow the cost of a two-day seminar as a deductible business expense. But if the seminar were offered on a cruise ship and spread out over a five- day period, the IRS would look closely if claimed as a deduction and not separated from the overall cost of the cruise