Don R. Hansen

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COST MANAGEMENT

• Don R. Hansen
• Maryanne M. Mowen

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Chapter Seven
Joint Product and By-Product Costing
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Learning Objectives

• Identify the characteristics of the joint
  production process.
  
• Allocate joint product costs according to
  benefits-received approaches and the relative
  market value approaches.
  
• Describe methods of accounting for by-products.

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Learning Objectives (continued)

• Explain why joint cost allocations may be
  misleading in management decision making.
  
• Discuss why joint production is seldom found in
  service industries.

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Joint Production Process
Pork Meat
Raw Material Hog
Processing
Hides
Split-Off Point
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Independent Multiple-Product Production
Mustang
Processing
Raw Material Steel
Processing
Taurus
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Joint Production Process

• Joint products are two or more products produced
  simultaneously by the same process up to a
  split-off point.
  
• The split-off point is the point at which the
  joint products become separate and identifiable.
  
• Separable costs are easily traced to individual
  products and offer no particular problem.

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Joint Production Costs(Manufacturing perfume)
Separable Costs
Processing 100,000
Charm 10,000 ounces _at_ 40 per ounce
Processing 400,000
Oil
Wild Scent 20,000 ounces _at_ 10 per ounce
Processing 300,000 (Flower Oil)
Wild Flower 50,000 ounces _at_ 1 per ounce
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By-Product Costs
Characteristics

• By-product resulting from scrap, trimmings, and
  so forth, of the main products in essentially
  nonjoint-product types of undertakings (e.g.,
  fabric trimmings from clothing pieces).
• Scrap and other residue from essentially
  joint-product types of processes (e.g., fat
  trimmed from beef carcasses).
  
• A minor joint product situation (fruit skins and
  trimmings used as animal feed).

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By-Products

• The distinction between joint and by-products
  rests solely on the relative importance of their
  sales value.
  
• A by-product is a secondary product recovered in
  the course of manufacturing a primary product.

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Examples of Joint Products and By-Products
Industry Joint Products and By-products
Agriculture and Food Industries
Flour milling Patent flour, clear flour,
middlings, bran, and wheatgem
Extractive Industries Copper mining Copper, gol
d, silver, and other metals Chemical Industries
Soap making Soap and glycerine Manufacturing
Cement Concrete pipe and aggregate
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Accounting For Joint Product Costs

• Benefits-Received Approaches
• Physical Units Method
• Weighted Average Method
• Allocation Based on Relative Market Value
• Sales-Value-at-Split-Off-Method
• Net Realizable Value Method

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Joint Costs Example
An Example Suppose that a sawmill processes logs
into four grades of lumber totaling 3,000,000
board feet as follows.
Board Weight Price at
Split-Off Grades Feet Factor (per 1,000 ft.)
1 450,000 1.30 300 2 1,200,000 1.10 200 3
600,000 1.00 121 4 750,000 .50 70 Total
3,000,000 Total joint cost is 186,00
0
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The Physical Units Method
Board Joint Cost Grades Feet
of Units Allocation 1 450,000 .15 27,900 2
1,200,000 .40 74,400 3 600,000 .20 37,200 4
750,000 .25 46,500 Total 3,000,000 18
6,000
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Weighted Average Method
Board Weight Weighted Allocated Grades
Feet Factor of Board Feet Percent Joint Cost
1 450,000 1.30 585,000 .2031 37,776
2 1,200,000 1.10 1,320,000 .4583 85,244
3 600,000 1.00 600,000 .2083 38,744
4 750,000 .50 375,000 .1302
24,217 Totals 3,000,000 2,880,000 100.00 186,0
00 Rounding
Error Grades with higher weights require more
cost to obtain the required finish and quality
appearance.
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Sales-Value-At-Split-off Method
Board Price at Sales Va
lue Allocated Grades Feet Split-Off at
Split-off Percent Joint Cost 1 450,000 300 135
,000 .2699 50.201 2 1,200,000 200 240,000 .47
99 89,261 3 600,000 121 72,600 .1452 27,007 4
750,000 70 52,500 .1050 19,530
Totals 3,000,000 500,100 100.00 186,000
Rounding Error
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Net Realizable Value Method
An Example Suppose that a company manufactures t
wo products, Alpha and Beta, from a joint
process. One production run costs 5,750 and
results in 1,000 gallons of Alpha and 3,000
gallons of Beta. Neither product is salable at
split-off, but must be further processed . The
separable costs for Alpha is 1 per gallon and
for Beta is 2 per gallon. The eventual market
price for Alpha is 5 and for Beta 4.
Further Hypothetical Hypothetical Market
Processing Market Number Market
Allocated Price Cost Price of Unit
s Value Joint Cost Alpha 5 1 4
1,000 4,000 2,300
Beta 4 2 2 3,000 6,000
3,450 10,000 5,750
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Constant Gross MarginPercentage Method
Using data from the previous example
Revenue (5 x 1,000) (4 x 3,000) 17,000 10
0 Costs 5,750 (1 x 1,000) (2 x 3,000)
12,750 75
Gross profit 4,250 25
Alpha Beta
Eventual market value 5,000 12,000
Less Gross margin _at_ 25 1,250 3,000
Cost of goods sold 3,750 9,000
Less Separable costs 1,000 6,000
Allocated joint costs 2,750 3,000

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Sales-To-Production-Ratio Method
Assume that 1,000,000 of joint cost was allocat
ed to five products based on the
sales-to-production ratio. Note that under this
method, less cost is assigned to slower moving
goods like Product C, which accounted for 25 of
production by only 15 of sales. A good like
Product B, which accounted for just 15 of
production but 20 of sales, receives relatively
more joint cost. The end result is that
relatively higher production cost is matched
against current revenues, and the company claims
lower net income for tax purposes.
of
of Sales-to-Production
Cost Assigned
Product Total Sales
Production Ratio
Percent Sales/Prod.
A 10 10 1.0000 19.9338 199,338
B 20 15 1.3333 26.5778 265,778
C 15 25 0 .6000 11.9603 119,603
D 40 30 1.3333 26.5778 265,778
E 15 20 0.7500 14.9504 149,504
100 100 5.0166 100.000 1,000,001

Rounding error
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Accounting for By-Product Costs
Given for a main product and a by-product
Total manufacturing costs of main product and by
-product 22,000 Total sales of main product 25,0
00 Estimated net realizable value of by-product p
roduced 2,000 Beginning inventories (including e
nding inventory of by-product) None
Ending inventory of main product is 25 of
production volume Ending inventory of by-product
is 10 of production volume
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Accounting for By-Product Costs(continued)
Sales of main product 25,000 Cost of goods s
old Total manufacturing costs 22,000 Deduc
t net revenue of byproduct (90 x 2,000)
1,800 Net manufacturing costs 20,200 Deduct
main product inventory (25 x 20,200) 5,050
Deduct byproduct inventory (10 x 2,000)
200 14,950 Gross margin 10,050
By-product revenue is treated as a reduction of
main product manufacturing costs.
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Accounting for By-Product Costs(continued)
Sales of main product 25,000 Add net revenue
of byproduct (90 x 2,000) 1,800
Total Sales 26,800 Cost of goods sold Tota
l manufacturing costs 22,000 Deduct main produ
ct inventory (25 x 22,000) 5,500
Deduct byproduct inventory (10 x 2,000)
200 16,300 Gross margin 10,500
By-product revenue is treated as a separate
revenue item.
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Effect of Joint Product Costs on Cost Control and
Decision Making

• It is important to understand when the use of
  allocated joint product costs may be misleading.
  
• In making decisions relative to jointly produced
  articles, it must be remembered that the products
  are necessarily produced jointly.
  
• Some areas that can be affected by joint cost
  allocations are
  
• Output decisions
• Further processing of joint products
• Pricing jointly produced products

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End of Chapter 7