Chapter 6:

6: Cost Allocation: Joint Products and Byproducts

Terms
> Joint costs are the costs of a single production process that yields multiple products
simultaneously.
> The Split-off point is the place in a joint production process where one or more
products become separately identifiable.
> Separable costs are all costs of manufacturing, marketing, distribution, & …. Incurred
beyond the split off point those are assignable to one or more individual products.
At or beyond the split off point, decisions relating to sale or further processing of individual
products can be made independently of decisions about other products.
The outputs of a joint production process can be classified into two general categories-
those with a positive sales value and those with a zero sales value. A product is any output
that has a positive net sales value (or an output that enables an organization to avoid
incurring costs).
 A joint product has relatively high sales value compared to other products yielded
by a joint production process
 When a joint production process yields only one product with a relatively high sales
value, the product is termed as main product.
 A byproduct has a relatively low sales value compared with the sales value of a
joint or main product.
Approaches to Allocating Joint Costs
Approach 1: Allocate costs using physical-measure-based data such as weight or volume.
Approach 2: Allocate costs using market based data such as revenues.
 Sales value at split-off point
 Estimated net realizable value (NRV) method
 Constant gross-margin percentage NRV method

Example1: Farmers Dairy purchases raw milk from individual farms and processes it until
the split-off point, where two products (cream and liquid skim) emerge. These two products
are sold to an independent company, which markets and distributes them to supermarkets
and other retail outlets.
 Raw milk processed 110,000 gallons. 10,000 gallons of raw milk are lost in the
production process due to evaporation, spoilage, and the like, yielding 100,000
gallons of good product.
Production Sales
Cream 25,000 gallons 20,000 gallons at Br. 8/gallon
Liquid skim 75,000 gallons 30,000 gallons at Br. 4/gallon
 Inventories
Beginning Inv Ending Inv
Raw milk 0 gallons 0 gallons
Cream 0 gallons 5,000 gallons
Liquid skim 0 gallons 45,000 gallons
 Cost of purchasing 110,000 gallons of raw milk and processing it until the split-off
point to yield 25,000 gallons of cream and 75,000 gallons of liquid skim, Br.
400,000.
How much of the joint costs of Br.400,000 should be allocated to the cost of goods sold
(20,000 gallons of cream and 30,000 gallons of liquid skim) and to the ending inventory
(5,000 gallons of cream and 45,000 gallons of liquid skim)?

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 1. Physical-Measure Method
> Allocates joint costs to joint products on the basis of the relative weight,
volume, or other physical measure at the split-off point of the total production
of these products during the accounting period.

2. Sales value at split of point

> Allocates joint costs to joint products on the basis of a relative sales value at the
split off point of total production of these products during the accounting period.

Note that the method uses the sales value of the entire production of the accounting period.
The reason is that the joint costs were incurred on all units produced, not just those sold in
the current period.

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 3. Estimated Net Realizable Value (NRV) Method
> In many cases, products are processed beyond the split-off in order to bring
them to a marketable form or to increase their value above their selling price at
the split-off point.
> The estimated net realizable value is typically used in preference to the sales
value at split-off point method only when market selling prices for one or more
products at the split-off point are available.

Eample2: Assume the same situation as in Example 1 except that both cream and
liquid skim can be processed further:
 Cream Butter cream; 25,000 gallons of cream are further processed to yield
20,000 gallons of butter cream at additional processing (separable) costs of Br.280,
000. Butter cream, sold for Br.25 per gallon, is used in the manufacture of butter-
based products.
 Liquid skim Condensed Milk; 75,000 gallons of liquid skim are further processed
to yield 50,000 gallons of condensed milk at additional processing costs of
Br.520,000. Condensed milk is sold for Br.22 per gallon.
 Sales during the accounting period were 12,000 gallons of butter cream and 45,000
gallons of condensed milk.

The estimated NRV method allocates joint costs to joint products on the basis of the relative
estimated NRV (expected final sales value in the ordinary course of business minus the
expected separable costs) of the total production of these products during the accounting
period. Joint costs would be allocated as follows:

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 4. Constant Gross-Margin Percentage NRV Method
> Allocates joint costs to joint products in such a way that the overall gross margin
percentage is identical for the individual products. This method requires 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 will bear
Step 3: Deduct the expected separable costs from the total costs to obtain the joint-
cost allocation.

Accounting for Byproducts

Joint production process may yield not only joint and main products but byproducts as
well. Although byproducts have much lower sales value than do joint or main products, the
presence of byproducts can affect the allocation of joint costs.

Example 3: The Meatworks Group processes meat from slaughterhouses. One of its
departments cuts lamb shoulders and generates two products:
Shoulder meat (the main product) – sold for Br.60 per pack.
Hock meat (the byproduct) - sold for Br.4 per pack.
Both products are sold at splitoff point without further processing. Data (number of
packs) for this department in July 2001 are as follows:
Production Sales Big. Inv. [Link].
Shoulder meat 500 400 0 100
Hock Meat 100 30 0 70
The joint manufacturing costs of these products in July 2001 were Br.25, 000
(comprising, Br.15, 000 for direct materials and Br.10,000 for conversion costs).

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 Method A: Byproducts Recognized at the Time Production is Completed
 This method recognizes the byproduct in the financial statements-the 100 packs
of hock meat-in the month it is produced (July 2001). The estimated net
realizable value from the byproduct produced is offset against the costs of the
main (or joint) products. The following journal entries illustrate this method:
1. Work in process 15,000
Account Payable 15,000
(To record direct materials purchased and used in production during July)
2. Work-in Process 10,000
Various Accounts 10,000
(To record conversion costs in the production process during July; examples include
energy, [Link], all Manu. labor, and plant maintenance)
3. Byproduct Inventory-Hock Meat (100*Br.4) 400
Finished Goods –Shoulder Meat (Br.25, 000-400) 24,600
Work-in Process (Br.15, 000+10,000) 25,000
(To record cost of goods completed during July)
4a. Cost of Goods Sold [(400/500)*24,600 19,680
Finished Goods-Shoulder Meat 19,680
(To record cost of the main products sold during July)
b. Cash (Account Receivable) 400*Br.60 24,000
Revenues –Shoulder Meat 24,000
(To record the sales of the main product during July)
5. Cash (Account Receivable) 30*Br.4 120
Byproduct Inventory- Hock Meat 120
(To record the sales of the byproduct during July)
This method reports the byproduct inventories of hock meat in the balance sheet at
their Br.4/pack selling price [(100-30)*Br.4 = Br.280].

Method B: Byproducts Recognized at Time of Sale

> This method makes no journal entries until sale of the byproduct occurs.
Revenues of the byproducts are reported as a revenue item in the income
statement at the time of sale.
In the Meat works Group example, byproduct revenues in July 2001 would be Br.120
(30*Br.4) because only 30 packs of the hock meat are sold in
July (of the 100 packs produced). The journal entries would be:
1 and 2: Same as for Method A.
3. Finished Goods-Shoulder Meat 25,000
Work-in Process 25,000
(To record cost of goods completed during July)
4a. Cost of Goods Sold [(400/500)*Br.25, 000 20,000
Finished Goods-Shoulder Meat 20,000
(To record cost of the main products sold during July)
4b. Same as for Method A
5. Cash (Account Receivable) 120
Revenues- Hock Meat 120
To record the sales of the byproduct during July)
Method B is rationalized in practice primarily on grounds that the dollar amounts of
byproducts are immaterial. However, this method permits managers to “manage”
reported earnings by timing when they sell byproducts.

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