Cost Allocation: Joint Products and By-products

1. Cost Allocation:Joint Productsand By-products

2. Key terms: • Joint products – two or more outputs produced simultaneously by a single manufacturing process using common input • Split-off point – the stage of processing where joint products are separated. • Joint cost – costs of processing two or more products prior to the split-off point; common cost • Byproducts– products that result incidentally from the joint products - Separable cost – cost after the split-off point

3. Consider the following example of an oil refinery. We will assume only two products,gasoline and oil. Joint Product Cost Allocation

4. JointProduct Costs Separate Processing Final Sale Oil Joint Production Process SeparateProcessing Costs Joint Input Separate Processing Final Sale Gasoline Split-Off Point SeparateProcessing Costs Joint Product Cost Allocation

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

6. Joint Costs MajorProduct Joint Production Process Joint Input MajorProduct Relatively lowvalue or quantitywhen compared tomajor products By-products Split-Off Point By-Products

7. Explain why joint costs should be allocated to individual products.

8. 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

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

10. Approach 1 a. Physical-UnitsMethod Joint Product Costs b. Net-Realizable- Value Method Allocating Joint Costs Approach 2 a. Relative- Sales- Value Method c. Gross margin Percent method

11. Allocation based on a physical measure of the joint products at the split-off point. Physical-UnitsMethod Allocation based onthe relative valuesof the products at the split-off point. Relative-Sales-Value Method Allocation based ona constant gross margin for all products. Allocation based onfinal sales values lessseparable processingcosts. Gross margin Percent Method Net-Realizable-Value Method

12. Joint conversioncost = $225,000 240,000 gallons Oil Joint Production Process Joint material cost = $275,000 360,000 gallons Gasoline Split-Off Point Physical-Units Method

13. Physical Measure Method Example $200,000 joint cost 20,000 pounds A 48,000 pounds B 12,000 pounds C Product A $50,000 Product B $120,000 Product C $30,000

14. Market-based Data Sales value at splitoff method Estimated net realizable value (NRV) method Constant gross-margin percentage NRV method

15. Allocating Joint Costs Example 1,000 units of A at a selling price of P100 = P100,000 Joint processing cost is P200,000 1,500 units of B at a selling price of P300 = P450,000 2,000 units of C at a selling price of P200 = P400,00 Splitoff point

16. Allocating Joint Costs Example A B C Total Sales Value P100,000 P450,000 P400,000 P950,000 Allocation of Joint Cost 100 ÷ 950 21,053 450 ÷ 950 94,737 400 ÷ 950 84,210 200,000 Gross margin P 78,947 P355,263 P315,790 P750,000

17. Sales Value at SplitoffMethod Example Assume all of the units produced of B and C were sold. 250 units of A (25%) remain in inventory. What is the gross margin percentage of each product?

18. Sales Value at SplitoffMethod Example Product A Revenues: 750 units × P100 P75,000 Cost of goods sold: Joint product costs P21,053 Less ending inventory P21,053 × 25% 5,263 15,790 Gross margin P59,210

19. Sales Value at SplitoffMethod Example Product A: (P75,000 – P 15,790) ÷ 75,000 = 79% Product B: (P450,000 – P94,737) ÷ P450,000 = 79% Product C: (P400,000 – $84,210) ÷ P400,000 = 79%

20. Estimated Net Realizable Value(NRV) Method Example Assume that MBA-TEP Company can process products A, B, and, C further into A1, B1, and C1. The new sales values after further processing are: A1: 1,000 × P120 = P120,000 B1: 1,500 × P330 = P495,000 C1: 2,000 × $210 = P420,000

21. Estimated Net Realizable Value(NRV) Method Example Additional processing (separable) costs are as follows: B1: P50,000 C1: P55,000 A1: P35,000 What is the estimated net realizable value of each product at the splitoff point?

22. Estimated Net Realizable Value(NRV) Method Example Product A1: P120,000 – P35,000 = P85,000 Product B1: P495,000 – P50,000 = P445,000 Product C1: P420,000 – P55,000 = P365,000 How much of the joint cost is allocated to each product?

23. Estimated Net Realizable Value(NRV) Method Example To A1: 85,000 ÷ 895,000 × P200,000 = P18,994 To B1: 445,000 ÷ 895,000 × P200,000 = P99,441 To C1: 365,000 ÷ 895,000 × P200,000 = P81,564

24. Estimated Net Realizable Value(NRV) Method Example Allocated Separable Inventory joint costscostscosts A1 P 18,994 P 35,000 P 53,994 B1 99,442 50,000 149,442 C1 81,564 55,000 136,564 Total P200,000 P140,000 P340,000

25. Constant Gross-MarginPercentage NRV Method This method entails three steps: Step 1: Compute the overall gross-margin percentage. Step 2: Use the overall gross-margin percentage and deduct the gross margin from the final sales values to obtain the total costs that each product should bear.

26. Constant Gross-MarginPercentage NRV Method Step 3: Deduct the expected separable costs from the total costs to obtain the joint-cost allocation.

27. Constant Gross-MarginPercentage NRV Method What is the expected final sales value of total production during the accounting period? Product A1: P 120,000 Product B1: 495,000 Product C1: 420,000 Total P1,035,000

28. Constant Gross-MarginPercentage NRV Method Step 1: Compute the overall gross-margin percentage. Expected final sales value P1,035,000 Deduct joint and separable costs 340,000 Gross margin P695,000 Gross margin percentage: P695,000 ÷ P1,035,000 = 67.15%

29. Constant Gross-MarginPercentage NRV Method Step 2: Deduct the gross margin. Sales Gross Cost of ValueMarginGoods sold Product A1: P120,000 P 80,580 P 39,421 Product B1: 495,000 332,392 162,608 Product C1: 420,000 282,030 137,971 Total P 1,035,000 P695,000 P340,000

30. Constant Gross-MarginPercentage NRV Method Step 3: Deduct separable costs. Cost of Separable Joint costs goods soldcostsallocated Product A1: P 39,421 P 35,000 P 4,421 Product B1: 162,608 50,000 112,608 Product C1: 137,971 55,000 82,971 Total P340,000 P140,000 P200,000

31. Explain why the sales value at splitoff method is preferred when allocating joint costs.

32. 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.

33. 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.

34. Avoiding Joint Cost Allocation Some companies refrain from allocating joint costs and instead carry their inventories at estimated net realizable value.

35. Explain why joint costs are irrelevant in a sell-or-process-further decision.

36. 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 1,000 A: P100 A1: P120 P35,000 1,500 B: P300 B1: P330 P50,000 2,000 C: P200 C1: P210 P55,000

37. Irrelevance of Joint Costsfor Decision Making Should A, B, or C be sold at the splitoff point or processed further? Product A: Incremental revenue P20,000 – Incremental cost P35,000 = (P15,000) Product B: Incremental revenue P45,000 – Incremental cost P50,000 = (P5,000) Product C: Incremental revenue $20,000 – Incremental cost P55,000= (P35,000)

38. 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.

39. End of ReportThank you