cooing te eed a Leaming Objective #3 ‘A. Introduction 1, The main objective of by-product accounting is to determine income and inventory for financial reporting purposes. By-products are of less significance than the main products and may not require precise cost allocation, 2, Relevant factors that influence by-product valuation and accounting include: The uncertainty of by-product value at the time of production. |The use of the by-product in other production, The use of the by-product as an alternative to main products. The need for separate profit calculations for sales incentives or for control 3. By-products can be accounted for using the following a. Noncost methods = Other income By-product revenue deducted from main product cost b. Cost methods ™ Replacement cost method Total costs less by-products valued at standard price method Joint cost proration method Noncost Methods of Accounting for By-Products Noncost methods make no attempt to allocate joint cost to the by-product or its in- ventory but instead make some credit either to income or to the main product. 1. Other Income Method a. The net sales of by-products for the current period is recognized as “Other In- come’ or "Miscellaneous Income” and is reported in the income statement. The market value of by-product inventory, if material, should be reported in a foot- note to the balance sheet. b. The other income method is used by those firms where: The value of the by-product is small, ™ Any other allocation would be more expensive than the benefits re- ceived, or ™ Carrying by-products with the main products would not appreciably affect the cost of the main product. ©. Disadvantages of this method include the following) ™ Inventories on the balance sheet are misstated since no value is placed on the by-products. | __ Matching of revenues with expenses is improper if production of by- products occurs in one accounting period and sales occur in another. No entry for by-products is made at the time of production, only at the time of sale. No attempt is made to control the inventory of by-products and to prevent them from losses due to fraud or errors. 2. By-Product Revenue Deducted from Main Product Costa. The net sales of by-products will be treated as a deduction from the cost of the main product. = Example: The beef-packing industry uses this method because of the great variety of products resulting from operations and the complexity of the processing. b. Disadvantages of this method include the following: = The method tends to understate the value of the main product. ™ The cost of the main product can vary from month to month be- cause of the varying quantities of by-products sold C. Cost Methods of Accounting for By-Products Cost methods attempt to allocate some joint costs to by-products and to carry invento- ries at the allocated cost levels. 1. Replacement Cost Method The replacement cost method values the by-product inventory at its opportunity cost of purchasing or replacing the by-products. = Example: In the oil refining industry, increasing output of one product will cause a reduction in the output and the profit of the other product. 2. Total Costs Less By-Products Valued at Standard Price Method a. By-products are valued at a standard price to avoid fluctuations in by-product value. b. The standard price approach shelters the main product cost from any fluctua- tions in the by-product price. c. The standard price may be set arbitrarily, or it may reflect an average price over time, d. A variance account is used to account for the difference between actual and standard prices. 3. Joint Cost Proration Method The by-product is allocated some portion of the joint costs using any one of the joint cost allocation methods mentioned in Section Il. This method is rarely used in practice.