ACCT3106 Management

Control
Tutorial Summary on Ch.16

Cost Allocation, Joint Products, and Byproducts

Part One:
Joint Production Process and
Methods of Joint Cost Allocation
 Lecture
Notes:
P. 3-9
The Joint Production Process
• In a joint production process, there will be two or more products
produced _simultaneously_.
• Petroleum Industry Example:

When processing petroleum, multiple products including

• Crude oil
• Raw LPG (liquid petroleum gas)
• Gas

are yielded simultaneously.

How much cost should be assigned to each of the joint products?
3
It touches with the issue of cost allocation.
 The Two Types of Output
under Joint Production Process

1. Joint Product/Main product

• Products with a relatively _high_ sales value

2. By-product
• Is incidental product resulting from the processing of another
product, and
• therefore, it has a relatively _low_ sales value as compared
Note the methods of to a main product.
by-product • Example: fat trimmed from beef
accounting treatment

Before doing the cost allocation, managers should distinguish which

products are main products and which are by-products.
The presence of by-product in the joint production process will affect
4 the amount of joint costs allocated to the main products (discussed later).
Decision point: should the company further process the intermediate products into final products?
Incremental income +ve, then further process
Intermediate products:
Final products:
Sales value at split-off (may not be available)
Final sales value
Joint Separable
Costs Costs
Further
Crude Oil Processing Product A

Processing Further
Petroleum LPG Processing Product B

Further
Gas Processing Product C

Estimated the final sales value and separable cost

Split-off Point
5 before further processing
 Some Important Cost Terms
in Joint Production Process
• Joint costs:
• Are the costs of a single production process yields two or more products
simultaneously.
• Joint costs include direct materials, direct labor and overhead costs incurred up
to the split-off point.

• Split-off point:
• Is the point at which the joint products become separable_ and identifiable_.

• Separable costs:
• Are all costs (further processing costs, marketing, distribution costs etc.) incurred
beyond_ the split-off point that are easily traced to individual products.
6
 4 Criteria to Guide Cost Allocation
When assigning joint costs to the joint products (Ch16) or assigning support
department costs to producing departments (Ch15), managers have to
select the appropriate criterion to implement the allocation

1. Criterion 1: cause-and-effect 
Managers need to find out the cost driver that causes the cost
object to change

For joint cost 2. Criterion 2: Benefits-received (based on sales revenue)

allocation
Managers need to identify the beneficiaries of the outputs of the
cost object (i.e. who get the benefits?)
e.g. R&D costs may be allocated to other divisions based on
sales since successful research and development effort can
7 lead to increased sales.
 Lead to cross
subsidization
3. Criterion 3: Ability to bear

More capable department/division/product needs to bear higher

costs.

e.g. the allocation of corporate executive salaries on the basis

of division operation income (which implies division with higher
operating income should absorb a larger amount of corporate
costs)

In joint cost allocations, the criterion that managers should consider is:
Benefits-received

8
 Allocating joint costs:
2 approaches
1. Physical Measure approach
• Allocating joint costs to joint products on the basis of the
relative weight, production volume or other physical
measure at the split-off point of the total production of
these products during the accounting period.
More preferred

2. Market-based Approach/Relative Market Value Approach

• Allocating joint costs using market-based data such as
_________. But why using revenue?
• As mentioned in previous slides, when doing cost
allocation, management should consider the cause-and-
effect and benefits-received criteria.
• Revenues are better indicator of ________ received than
9
are physical measures.
 Lecture
Notes:
Physical Measure-based Approach P. 26-29

Example:

Waltz company incurred $200,000 joint costs

(DM+DL+O/H) to produce the following products:
Product A: 10,000 units (20,000 pounds)
Product B: 10,500 units (48,000 pounds)
Product C: 11,500 units (12,000 pounds)
80,000 pounds

What are the joint costs allocated to each product using the
10
number of pounds produced as a physical measure?
 For determining the
ending inventory value

Product A: $200,000 x 20,000/80,000 = $50,000

(unit joint cost = $50,000/20,000 = $2.5/pound

Product B: $200,000 x 48,000/80,000 = $120,000

(unit joint cost = $120,000/48,000 = $2.5/pound)

Product C: $200,000 x 12,000/80,000 = $30,000

(unit joint cost = $30,000/12,000 = $2.5/pound)

 Unit joint cost is the same for all the three products.

11
 Problems of physical-measure method
1. This method actually has no relationship to the revenue-
producing power of the individual products. That is, this
method does not support the benefits-received criterion.
e.g. Try to think about a mine that extracts ore containing gold, silver,
and lead. Using common physical measure – tons, would result
in almost all the costs being allocated to the product that weighs
the most – lead. However, lead actually has the lowest revenue-
generating power. Profit distorted

2. Obtaining comparable physical measure (e.g., Gas vs Solid

vs Liquid) for all joint products is not always easy.

e.g. Think about the case of processing petroleum, where oil is a

liquid and gas is a vapor. Finding a common physical
measure to allocate the joint costs may not be a
straightforward task, and technical expertise may be required.
12
 The Market-based Approach
(use sales value as the base)
The best
choice if sales
Three choices: value at split-
off point of the
products are
1. The Sales value at split-off method available.

2. The Estimated Net Realizable Value Can apply

only when
(NRV) method further
processing
3. Constant Gross-Margin % NRV method occurs

13
Is sales value (based on production volume) same as sales
revenue (based on sales volume)? NO Lecture
Only when there is no ending inventory, they will be the same Notes:
P. 11-17
Sales-value at split-off method
• This method allocates joint costs to joint products on
the basis of the relative sales value at the split-off
point of the total production of these products.
• As long as the prices at split-off point are stable or
the rate of change in prices of various products are
the same, the amount of joint costs allocated to each
product remain constant.

14
 Waltz Example (Cont’d)

Product Production Sales value/unit Ending Inventory Sales volume

A 10,000 units $10 2,500 units 7,500 units
B 10,500 units $30 0 10,500 units
C 11,500 units $20 0 11,500 units

Assume there is no beginning inventory for all the joint products.

Sales value at split-off:

A: $10 x 10,000 = $100,000 (but NOT $10 x 7500 units)
B: $30 x 10,500 = $315,000
C: $20 x 11,500 = $230,000
15
$645,000
Based on production volume but NOT sales volume
 Recall that the joint costs incurred is $200,000. Based on the sales-value at split off calculated in
previous slide, the amount of joint costs allocated to each product should be:

A: $100,000/$645,000 x $200,000 = $31,008

B: $315,000/$645,000 x $200,000 = $97,674

C: $230,000/$645,000 x $200,000 = $71,318

Total $200,000

Joint costs per unit:

A: $31,008/10,000 units = $3.1 per unit for determining the ending inventory of A

B: $97,674/10,500 units = $9.3 per unit

C: $71,318/11,500 units = $6.2 per unit

Note: when using this method to allocate joint costs, we should use the sales
value of the total production rather than the sales value of the units sold.
The reason is that the joints costs are incurred on all the units _produced_
16 but not just those units sold.
The gross margin percentage of each product:

Income Statement
A B C
Revenues: $75,000 $315,000 $230,000 Based on sales volume
Less: Cost of Goods Sold
Beginning Inventory 0 0 0
Add: Joint costs 31,008 97,674 71,318
Managers can compare the
Less: Ending inv- A: 2500 x3.1 ( 7,752) 0 0 GM% of joint product package
23,256 97,674 71,318 A.B C with another joint product
package, say D E F.

Gross profit 51,744 217,326 158,682 However, it’s NOT appropriate

to compare the GM% of the
Gross Margin % 69% 69% 69% individual products WITHIN the
joint product package.

Note that the gross margin % of each product is the same under the sales-value at split-off method.

17
 Discussion question Purpose of joint-cost allocation

18
 1a) Sales value at split-off method:
Parts Pounds of Selling sales value Weighting
Product Price at split-off
Breasts 100 $0.55 $55.0 67.5%
Wings 20 0.20 4.0 4.9%
Thighs 40 0.35 14.0 17.2%
Bones 80 0.10 8.0 9.8%
Feathers 10 0.05 0.5 0.6%
81.5 100.0%

Cost of the special shipment destroyed:

- 40 pounds of breasts: 67.5% x $50 x 40/100 = $13.5
- 15 pounds of wings: 4.9% x $50 x 15/20 = $1.8
$15.3

19
 1b) Physical-measure method
Parts Pounds of Weighting
Product
Breasts 100 40%
Wings 20 8%
Thighs 40 16%
Bones 80 32%
Feathers 10 4%
250 100%

Cost of the special shipment destroyed:

- 40 pounds of breasts: 40% x $50 x 40/100 = $8
- 15 pounds of wings: 8% x $50 x 15/20 = $3
$11

20
 2) The sales value at split-off method captures the benefits-received criterion
but the physical measure method does not. Therefore, the sales value
at split-off method is preferred. Under the sales-value at split-off method,
the joint cost is allocated to products in proportion to the ability to
contribute revenue. The company’s decision to process chicken is
heavily influenced by the revenues from breasts and thighs. The _bones_
provide relatively few benefits to the company despite their high physical
volume.

21
Part Two:
Methods of Joint Cost
Allocation (Cont’d)
 Lecture
The Estimated Net Realizable Value (NRV) method Notes:
P. 18-20
(applies to joint products that are further processed)
• Sometimes sales-value at split-off for the joint products may not be
available, and the joint products may be processed further beyond the
split-off point in order to bring them to a marketable form or to increase
their value above their selling price at split-off point.

• Estimated NRV = expected final sales value - expected separable costs

Costs that are of the total production

incurred beyond
the split-off point

•This method can only apply to products that are further processed. Why?
If the products at the split-off point are not further processed, there will be
23 no separable costs incurred and no NRV can be obtained.
 Waltz Example Cont’d
• Assume that products A,B, and C are further processed in A1, B1 and C1 respectively

Product Production Separable costs Final Sales Value

A1 10,000 $35,000 $12

B1 10,500 $46,500 $33

C1 11,500 $51,500 $21

$133,000

Again, the Expected final sales value after further processing:

final sales value A1: 10,000 x $12 = $120,000
is based on total B1: 10,500 x $33 = $346,500
production volume C1: 11,500 x $21 = $241,500

Estimated NRV = final sales value – separable costs

A1: $120,000 - $35,000 = $85,000
B1: $346,500 - $46,500 = $300,000
24
C1: $241,500 - $51,500 = $190,000
Total $575,000
 Joint costs allocated to each product:

A1: 85/575 x $200,000 = $29,565

B1: 300/575 x $200,000 = $104,348

C1: 190/575 x $200,000 = $66,087

Total $200,000

Product cost per unit:

Product Allocated Joint costs Separable costs Total Cost/unit

A1 $29,565 $35,000 $64,565 $6.46

B1 $104,348 $46,500 $150,848 $14.37

C1 $66,807 $51,500 $117,587 $10.22

Note the gross margin % for the products are NOT the same under the NRV method.
25
 Waltz Example Cont’d
Lecture Notes:
Constant gross-margin % NRV method P. 21-25

(also applies to products that are further processed)

• This method allocates joint costs to joint products in such a way that the overall gross-
margin percentage is identical for each of the individual products.
Working backward to find out the JC assigned

• Step 1: calculate the overall gross-margin %

Total expected final sales value for all the products $708,000*

Less: joint and separable costs $200,000 + $133,000 ($333,000)

Gross Margin 375,000

 Gross Margin % = $375,000/$708,000 x 100% = 53%

*Note
Expected final sales value for all products = 10,000 x $12 + 10,500 x $33 + 11,500 x $21
26
= $708,000 (remember to use production vol. here)
 • Step 2: Deduct the gross margin from the final sales value to get the COGS for each product

A1 B1 C1

Expected final sales value $120,000 $346,500 $241,500 (based on production vol.)

Less Gross margin (final sales value x 53%) 63,600 183,645 127,995

COGS 56,400 162,855 113,505

• Step 3: Deduct the separable cost from the COGS to find the amount of joint costs allocated to each
product

COGS (includes joint and separable costs) 56,400 162,855 113,505

Less: Separable costs (35000) (46,500) (51,500)

Joint costs allocated 21,400 116,355 62,005

The gross margin % for the products, of course, is the same!

27
 Lecture
Notes:
P. 33
Which market-based method is preferred?
• The _sales split-off (not sure)__method is the most
widely used method because
• It is simple
• and it does not require subsequent management decisions on
further processing, that means management does not need to
estimate the amount of separable costs and the final sales value
of the joint products.

• But when sales value at split-off method cannot be used?

when there is NO market price existed for the joint

product at split-off point.
 then NRV methods should be used.
28
 Any disadvantages for the market-based approach? YES!

• Change in the market value of any one or more of the end

products automatically changes the apportionment of the _joint_
costs though actually no more or no less to produce than before.

• Under sales value at split-off and the constant gross-margin

percentage methods, all the joint products have the _same_ gross
margin percentage. This will mislead the managers to think that
the products are equally performing good and thereby affect their
product decisions.

Also refer to the problems of physical measure method in slide 12.

29
 Lecture
Notes:
P. 10
The Pitfalls of Allocating Joint Costs

Actually, no matter which allocation base to use (physical measure

based or market-based), the process of joint cost allocation is
somewhat arbitrary.
Therefore, managers must avoid using joint costs for such economic
decisions as pricing .

The main purposes of joint cost allocation are

• for determining the inventory value and cost of goods sold in the
financial statements.
• for preparing internal reports like division profitability analysis

30
Assignment question

31
 Part 1a) NRV method
200 x $1,200 $580,000 x 24%

Products Production Expected final Separable NRV Weighting JC

volume sales value Costs allocated
X 68 +132 = 200 $240,000 -- $240,000 24% $139,200
Y 480+120 = 600 $540,000 -- $540,000 54% $313,200
Z 672 + 28 = 700 $420,000 $200,000 $220,000 22% $127,600
$1,000,000 100% $580,000

Cost of inventories for X,Y and Z:

X: $139,200 x 132/200 = $91,872
Y: $313,200 x 120/600 = $62,640
Z: ($127,600 + $200,000) x 28/700 = $13,104
32
 Part 1b) Constant gross-margin percentage NRV method

Total expected final sales value for all products

($1,200 x 200 + $900 x 600 + $600 x 700) 1,200,000
Less: joint costs and separable costs (580,000 + 200,000) (780,000)
Gross margin 420,000

Gross margin % (420,000/1.2m) 35%

X Y Z
Expected final sales value
($1,200 x 200; $900 x 600; $600 x 700) 240,000 540,000 420,000
Less: gross margin (35%) (84,000) (189,000) (147,000)
Total production costs 156,000 351,000 273,000
Less: separable costs -- -- (200,000)
Joint costs allocated 156,000 351,000 73,000

Cost of inventories for X, Y and Z:

X: $156,000 x 132/200 = $102,960
Y: $351,000 x 120/600 = $70,200
Z: (73,000 + $200,000) x 28/700 = $10,920

33
 2) Gross-margin % for X,Y, and Z using NRV method

Income Statement
X Y Z
Revenues
($1,200 x 68; $900 x 480; $600 x 672) 81,600 432,000 403,200
Less: Cost of goods sold
Joint costs allocated 139,200 313,200 127,600
Separable costs -- -- 200,000
Total production costs 139,200 313,200 327,600
Less: ending inventories (91,872) (62,640) (13,104)
COGS 47,328 250,560 314,496
Gross margin 34,272 181,440 88,704

Gross margin % 42% 42% 22%

Same GM% as X and Y are not further processed.

Actually, the joint costs are allocated to these products
Comparison: based on their sales value at split-off.
X Y Z
34 NRV method 42% 42% 22%
Constant gross margin % NRV 35% 35% 35%
 Lecture
Making sell-or-process Further Decision Notes:
P. 30-32
(Is joint cost relevant in making such decision?)

• As mentioned, the main purpose of allocating joint cost is for inventory costing. Usually, joint
cost allocation is NOT useful for internal economic decisions like pricing, comparing individual
product performance and further processing

• Joint costs incurred up to the split-off point are PAST costs (already incurred)
 therefore, they are not relevant to the decision to sell a joint product at the split-off point or to
process it further.

Recall the data in the Waltz example:

Production Sales value at split-off Final sales price Additional/Separable costs
10,000 A: $10 A1: $12 $35,000
10,500 B: $30 B1: $33 $46,500
11.500 C: $20 C1: $21 $51,500
35
Should A,B, and C be sold at split-off point or processed further?
  We should compare the incremental revenue and incremental cost

A: Incremental revenue ($12-$10) x 10,000 = $20,000

Incremental cost (i.e. the separable cost) = $35,000

(15,000)

 should sell at split-off rather than process further to A1.

B: Incremental revenue ($33-$30) x 10,500 = $31,500

Incremental cost = $46,500

(15,000)

 should sell at split-off.

C: Incremental revenue ($21-$20) x 11,500 = $11,500

Incremental cost = $51,500

(40,000)
36

 should sell at split-off.

Part Three:
By-product Accounting
Treatment
 Lecture
Notes:
Accounting Treatment for by-product P. 34-39

• Recall the distinction between by-products and joint-products. By-products have much
lower sales value than do joint products.

• The presence of by-products affects the amount of joint costs absorbed by the main
products.

• 2 main methods are available to recognize the by-product:

1. Production method (cost method): recognizes by-product at the time of production
2. Sales method (non-cost method): recognizes by-product at the time of sale

Accounting treatment refers to when the company prepares the journal entries to
record the by-products and this does not relate to when the company actually sells
the by-products. That means, even though production method is adopted, it does
not mean the company piles up the by-products and does not sell them.
38
 Production method/Cost method:
• Which recognizes by-products in the financial statements at the time of
production is completed
• By the time of the production completed, the management has no
information on how many units of the by-products can be sold This is called the
• NRV of the by-products
Therefore, by-product revenue will NOT be recognized.
• Rather the by-product’s sales value of total production (no of units produced
x sales price per unit) will be deducted from the joint costs to determine the
net production cost allocated to the main product.
• Some of the joint costs are allocated to the by-products.

Needs to record
Partly assigned to the by-products by-product ending
(by-product’s sales value x by product’s total production) inventory in Balance
Sheet
Joint costs
Of course, main
Remaining amount of J.C. assigned to the main products product ending
39
inventory should
also be recorded in
Balance sheet shows both by-product and main product ending inventory. Balance Sheet
 Sales method/Non-cost method
• This method delays the recognition of byproducts until the time of sale.

• By-product revenue (no. of units SOLD x sales price per unit) is shown
in the company’s income statement as one of the revenue sources
(usually the by-product revenues appear in the “other income” section
in the income statement.)

• All the joint costs are allocated to main products

Joint costs Wholly assigned to the main products Balance sheet only shows main product
ending inventory.

40
 Example:
Main Product By-product
Production 1000 yards 400 yards
Sales (800) (300)
Ending Inventory 200 100

Sales price $13/yard $1/yard

No beginning finished goods inventory

Joint costs incurred: $9000

41
 Partial Income statement of the main products

Production method Sales method

Revenues $ $

Main products ($13 x 800) 10,400 10,400

By-products ($1 x 300) -- 300

Total revenues 10,400 10,700 Difference 1

Cost of goods sold (of main products)

Total production cost (joint cost) 9,000 9,000

Less: by product NRV ($1 x 400) (400) -- Difference 2

See summary
production volume
at the back
Net production cost to main products 8,600 9,000 Difference 3
Less: main product ending inv. (1,720)* (1,800)* Difference 4

COGS 6,880 7,200 Difference 5

42
Gross Margin 3,520 3,500 Difference 6
* Value of the ending inventory = 200/1000 x net production cost
 Summarizing the differences between production and sales method
Production Sales
method method

1. By-product revenue recognized? No Yes

2. Total Revenue Lower Higher
(Main Product + By-product)
3. Joint cost allocated to main product Lower Higher
(by-product NRV deducted from joint cost under prod.
method)

4. Main product ending inventory value Lower Higher

(with lower net production cost, the value of main product
ending inventory will be lower under production method)

5. Cost of goods sold Lower Higher

(by-product costs were recognized at production, implying
part of the COGS was allocated to by-products. This makes
the COGS of main products lower under the cost method.)

6. Gross Margin Higher Lower

(with lower main product ending inventory and with lower
COGS, gross margin under the production method tends to
43
be higher. Also note that in sales method, the higher revenue
earned cannot cover the higher COGS. However, which
method gives higher GM depends case-by-case)
 Assignment question

44
 Part 1:
$50 x 67.5%
Parts Pounds of Selling sales value Weighting Joint cost Joint cost
Product Price at split-off allocated per pound
Breasts 100 $0.55 $55.0 67.5% 33.75 0.3375
Wings 20 0.20 4.0 4.9% 2.45 0.1225
Thighs 40 0.35 14.0 17.2% 8.60 0.2150
Bones 80 0.10 8.0 9.8% 4.90 0.0613
Feathers 10 0.05 0.5 0.6% 0.30 0.0300
81.5 100.0% 50.00

Ending inventory value for each product:

Parts Ending inventory J.C. per pound Value of ending inventory

Breasts 15 0.3375 5.0625
Wings 4 0.1225 0.4900
Thighs 6 0.2150 1.2900
Bones 5 0.0613 0.3065
Feathers 2 0.0300 0.0600
7.209
45
 Part 2:
Or net joint costs
Net production cost = joint costs – net realizable value of by-products
= $50 – 20 x 0.2 – 80 x 0.1 – 10 x 0.05
= $37.5
37.5 x 79.71%

Parts Pounds Selling Sales value Weighting J.C. J.C.

of product Price at split-off allocated per pound
Breasts 100 $0.55 $55 79.71% $29.89 $0.2989
Thighs 40 $0.35 $14 20.29% $7.61 $0.1903
$69 $37.50

Ending inventory value:

Breasts: 15 pounds x $0.2989 = $4.4835
Thighs: 6 pounds x $0.1903 = $1.1418
$5.6253

46
 Part 3:

In requirement 1, all the products are treated as joint products. Quality Chicken does not
need to judge whether a product is a joint product or a byproduct. In requirement 2, wings
bones and feathers are treated as by products. The amount of joint costs allocated to
the main products (breasts and thighs) is lower because the amount of net realizable
value is deducted from the joint costs.

47