Other costing

Chapter 4 techniques
Chapter Content
Other
Other costing
costing
techniques
techniques

Joint
Joint product
product Throughput
Throughput Costing
CostingDigital
Digital
costing
costing accounting
accounting Products
Products
 Joint Product Costing
Joint cost is the manufacturing cost incurred on a joint production
process which takes common inputs but simultaneously produces
multiple products called joint products e.g. processing of crude oil
simultaneously yields gasoline, diesel, jet fuel, lubricants and other
products.
 Joint product costing
Used when more than one product is produced in the same process at the
same time
 Joint Product Costing
In order to allocate costs to such joint products, accountants need to
employ a suitable cost allocation method on consistent basis. Most
common of those methods are:
1) Physical measurement method (production units)
Joint costs are allocated based on number of units or physical
quantity such as weight, volume or length of each product relative
to total production. This method can be represented in the following
formula:
Cost Allocated to a Joint Product =
Quantity of the Product
x Total Joint Costs
Quantity of Total Production
 Joint Product Costing
2) Relative sales value method (also known as market value)
This method allocates joint costs on the basis of estimated sales
value of a given joint product relative to the sales value of total joint
production. This is illustrated in the following formula:
Cost Allocated to a Joint Product =
Sale Value of the Product
x Total Joint Costs
Sales Value of Total Production

This method is suitable when physical quantity of joint products does not
reflect their value and a reliable estimate of their sale value can be easily made.
 Joint Product Costing
3) Net realizable value method
For products that need further processing, NRV method is more
suitable because it takes into account, the additional costs needed
to further process and sell the joint products. Under this method,
joint cost is allocated to products using the following formula:
Cost Allocated to a Joint Product =
NRV of the Product
x Total Joint Costs
NRV of Total Production

Where,
NRV = Estimated Sales Value − Estimated Cost to Further Process and Sell

When such products are further processed after split-off, their total costs also
include further processing cost.
 Joint Product Costing
Sell-or-Process-Further Decision
A decision whether to sell a joint product at split-off point or to process
it further and sell it in a more refined form is called a sell-or-process-
further decision
The point at which joint products leave the joint process is called split-
off point
Some of the joint products may be in final form ready for sale, while
others may be processed further. In such cases managers have to decide
whether to sell the unfinished goods at split-off point or to process
them further.
 Joint Product Costing
A sell-or-process-further analysis can be carried out in three different ways:
Incremental (or Differential) Approach calculates the difference between the
additional revenues and the additional costs of further processing. If the
difference is positive the product must be processed further, otherwise not.
Opportunity Cost Approach calculates the difference between net revenue
from further processed product and the opportunity cost of not selling the
product at split-off point. If the difference is positive, further processing will
increase profits.
Total Project Approach (or the comparative statement approach) compares the
profit statements of both options (i.e. selling or further processing) separately
for each product. The option generating higher profit is chosen.
 Joint Product Costing
(Illustrative Problem)
Product A and B are produced in a joint process. At split-off point,
Product A is complete whereas product B can be process further. The
following additional information is available:
Product A B
Quantity in Units 5,000 10,000
Selling Price Per Unit:
At Split-Off $10 $2.50
If Processed Further $5
Costs After Split-Off $20,000

Perform sell-or-process-further analysis for product B.

 Joint Product Costing
(Illustrative Solution)
1) Incremental Approach:
Incremental Revenue: $25,000
Incremental Costs 20,000
Increase in Profits Due to Further Processing $ 5,000

2) Opportunity Cost Aproach:

Sales in Case of Further Processing $50,000
Costs:
Additional Costs 20,000
Opportunity Cost of Not Selling at Split-Off 25,000
Gain on Further Processing $ 5,000
 Joint Product Costing
(Illustrative Solution)
3) Total Project Approach:
Split-Off Further
Point Processed
Revenue $25,000 $50,000
Costs 0 20,000
Net Revenue $25,000 $30,000
Gain from Further Processing $ 5,000

Some joint products need a separate production process after the split-off point to
convert them into the finished good. There could be joint products that are saleable
when they arrive at the split-off point, but they may still need some processing to add
more value. In such a case, it is the responsibility of the management to examine
whether or not they benefit from the additional work will be more than the costs of
the other
 Accounting for by-products
Almost every production process results in additional products which aren’t
the main, intended products. As well as the main product and by-product,
production processes can also generate spoilage and joint products.
Whereas by-products are secondary products that usually have market
value, and can therefore be processed and sold on, the spoilage has no
market value and is therefore disposed of.
• The by-products do not pick up a share of the costs.
• The sales value of the by-product at the split-off point is treated as a
reduction in costs instead of an income.
• If the by-product has no known value at the split-off point but does have
a value after further processing, the net income of the by-product is used
to reduce the costs of the process
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.
 Accounting for Byproducts
Example
Main Products Byproducts
(Yards) (Yard
Production 1,000 400
Sales 800
Ending inventory 200 100
Sales price $13/yard $1.00/yard
No beginning finished goods inventory
 Accounting for Byproducts
Example

Joint production costs for joint

(main) products and byproducts:
Material $2,000
Manufacturing labor 3,000
Manufacturing overhead 4,000
Total production cost $9,000
 Accounting for Byproducts
Method A
Method A: The production method
What is the value of ending inventory
of joint (main) products?
$9,000 total production cost
– $400 net realizable value of the byproduct
= $8,600 net production cost for the joint products
 Accounting for Byproducts
Method A
200 ÷ 1,000 × $8,600 = $1,720 is the value
assigned to the 200 yards in ending inventory.
What is the cost of goods sold?
Joint production costs $9,000
Less byproduct revenue 400
Less main product inventory 1,720
Cost of goods sold $6,880
 Accounting for Byproducts
Method A
Statement of Income (Method A)
Revenues: (800 yards × $13) $10,400
Cost of goods sold 6,880
Gross margin $ 3,520
What is the gross margin percentage?
$3,520 ÷ $10,400 = 33.85%
 Accounting for Byproducts
Method A
What are the inventoriable costs?
Main product: 200 ÷ 1,000 × $8,600 = $1,720
Byproduct: 100 × $1.00 = $100
Accounting for Byproducts
Method B
Method B: The sale method
What is the value of ending inventory of
joint (main) products?
200 ÷ 1,000 × $9,000 = $1,800
No value is assigned to the 400 yards of
byproducts at the time of production.
The $300 resulting from the sale of
byproducts is reported as revenues.
 Accounting for Byproducts
Method B
Statement of Income (Method B)
Revenues: Main product (800 × $13) $10,400
Byproducts sold
Total revenues
Cost of goods sold:
Joint production costs 9,000
Less main product inventory 1,800 $ 7,200
Gross margin
 Accounting for Byproducts
Method B
What is the gross margin percentage?
$3,200 ÷ $10,700 = 29.91%
What are the inventoriable costs?
Main product: 200 ÷ 1,000 × $9,000 = $1,800
By-product: -0-
 Throughput Accounting
 Throughput Accounting is a modern management accounting technique
that offers an alternative view to the more traditional cost accounting.
 It’s all about identifying the constraint or limiting factor in the
production process and exploiting it to maximise profit. It allows
management to focus efforts to make the best possible use of the
limitation.
 The constraint in a manufacturing environment is also referred to as a
“bottleneck”
 Throughput accounting is concerned with identifying and removing
bottlenecks
 Prioritise production on the basis of throughput per usage of the scarce
resource
 Throughput Accounting
Formula and Ratios
1) Throughput $ = Sales Revenue less Direct Material Costs
2) Throughput Accounting Ratio (TPAR) = Return per factory hour/Cost
per factory hour
a) Return per factory hour = Throughput $ per unit/Time per unit
b) Cost per factory hour = Total factory cost/Total time available

The two key formulas here are the Throughput $ and the
TPAR – the other formulas are required to understand how to
calculate the TPAR.
Throughput Accounting
(Illustrative Problem)
 Throughput Accounting
(Illustrative Problem)
Production Plan to Maximise Profit
1) The TOC Theory of Constraints in this scenario is the fact the total
machine hours is just 32,500 yet to fulfill the demand required we would
need 35,000 hours (15,000*2)+(5000*1).
2) To calculate the production plan to achieve the maximum profit we need
to find the Throughput value per machine hour, which we know is the
Selling Price less the Materials/the total machine hours per unit.
Product A: $175 (275-90)/2 hours = $92.50
Product B: $125 (325-165)/1 hour = $160
With this mind, we need to exploit the constraint by maximising the
production of Product B as it gives the highest throughput value and filling
the rest of the time with Product A to achieve the maximum profit in these
conditions.
 Throughput Accounting
(Illustrative Problem)
Proposed Production Plan
Product B: 5000 units x 1 hours = 5,000 machine hours
Product A: 13,750 units x 2 hours = 27,500 machine hours
Below is a summary of the financials based on this production plan.
 Throughput Accounting
(Illustrative Problem)
 You can see the total throughput profit (which is considering just the
direct materials as a variable cost) gives over 2m profit.
 However, the factory (or total fixed costs) need to considered and
this is based on the number of units in the original demand and not
the proposed production plan as the fixed costs will be incurred
regardless of any constraint.
 The final result would be a total maximum profit of 421,875.
 Throughput Accounting
(Illustrative Problem)
TPAR – Throughput Accounting Ratio
 Finally, let’s look at the TPAR based on the above scenario and see
what that tells us.
 The TPAR ratio is calculated on each product and is done by dividing
the Return Per Factory Hour against the Cost Per Factory.
 Throughput Accounting
(Illustrative Problem)
You can see that both products have a ratio above 1 which means that
the product will be profitable – in simple terms in means that the
throughput profit is greater than the fixed costs. In fact you can see that
Product B gives a TPAR of a whopping 3.15, so making over three times
profit in relation to the fixed costs.
 Throughput accounting
• Throughput accounting is very similar to marginal costing, but
it can be used to make longer term decisions about
capacity/production equipment.
• Throughput accounting is based on three concepts:
throughput, inventory (or investment) and operating
expenses.
• Managers should aim to increase throughput while
simultaneously reducing inventory and operational expense.
Inventory valuation using throughput
• Inventory should be valued at the purchase cost of its raw
materials and bought in parts.
• It should not include any other costs, not even labour costs.
No value is added by the production process, not even by
labour, until the item is sold.
 Maximising throughput
• If the business has more capacity than there is customer
demand, it should produce to meet the demand in full.
• If the business has a constraint that prevents it from meeting
customer demand in full, it should make the most profitable
use that it can of the constraining resource. This means giving
priority to those products earning the highest throughput for
each unit of the constraining resource that it requires.
 Digital Costing
A digital products typically refers to a product that is stored, delivered and
consumed in an electronic format. The product can be delivered in many
ways such as through a website, a mobile phone application or Email.
Examples include:
 Online courses
 Apps
 eBooks
 Software
 Graphics
 Downloadable music
 Digital Costing
The differences between Traditional Costing systems and Digital Costing
 Marginal costs can be virtually be zero for many digital products and most cost
are likely to be fixed in nature. This means digital products are expensive to
produce but cheaper to reproduce.
 There is often no standard time or cost that can be that can be attributed to
digital products, making the use of standard costing inappropriate
 Drivers for overheard can be very difficult to determine in digital costing
 The timing of the cost can be difficult to estimate and can be extended over a
number of accounting periods.
 The lifespan of digital products can vary greatly. Some products may take a
longer period than the other products.
 Many product features or functions might be shared amongst a number of
products
 Digital Costing
Benefits of digital costing systems
These can be classified as:
1) The system allows the organisation to automatically compare prices and
suppliers giving the organisation access to the cheapest, this results in cost
savings to the organization
2) The organisation will be continuously updated and reflecting current
information, this will allow the organisation to change and adapt to
changes.
3) The organisation will have access to more suppliers and this can bring
benefits such as quicker lead times and access to more variety of
resources.
4) Digital costing systems have built in analytics and intelligence capabilities.
They can analyse changes over
 Digital Costing
5) Digital costing systems have built in analytics and intelligence
capabilities. They can analyse changes over time and supplier
flexibility
6) Digital costing systems have the ability to accurately cope with
hundreds of purchasing decisions at one time. They are also easy to
use and quickly understood by decision makers
7) The organisation will receive better, more up to date information on
the cost of its product. This will includes better knowledge of drivers
and absorption of costs of products.
8) It allows for a more detailed breakdown of overheards with more
personalised cost drivers.
 Digital Costing
9) This can help in cost control
10) Digital costing systems make cost behavior much easier to
understand. There is clearer information on the split of semi variable
costs so that organizations has a better understanding of the costs
which are purely variable.
 Digital Costing
Costing of digital products
Standard costing for digital products is often inappropriate because:
1) Marginal costs such as materials are likely to be zero for digital products
2) Lifespan of products can be uncertain – sometime as short as one day –
sometimes much longer due to the updates and changes which can be
added
3) Overheads and their drivers are difficult to identify
4) Rapid changes in technology can affect costs and selling prices with little
warning
5) Digital products can evolve over different accounting periods. There are
likely to have large upfront design costs and incur later costs for royalties,
testing and marketing
 Digital Costing

Suggest some costs

which might be
involved in creating
Example 1 a digital audio book
– can you suggest
(CIMA: November any costs which
2019 Examinations) might be saved in
comparison to
manufacture of
physical books?
 Digital Costing
Answer to Example 1
1) Types of costs – e-books
 Software expertise
 Royalties for author
 Design costs for cover image
 Marketing costs
 IT support ongoing for updates etc
 License/ commission paid to advertise on audio book site.
2) Note – many of these are fixed and paid up front.
3) Once the product is created, the cost of selling it again and again has virtually no extra
cost.
4) Costs saved
Compared to physical manufacturing of books -there are no inventory storage or holding
costs or
any transportation costs.