Chapter -5

Accounting for Joint products and by products

Joint Process/ Joint products

A Joint process is a production process that simultaneously converts a common input into
several outcomes. For example, processing timber results jointly into lumber of various
grades plus woodchips and sawdust that can be converted into paper pulp. Pulp can be sold or
processed further in to paperboard. Another example, processing crude oil can result jointly
in gasoline of various grades, kerosene, jet fuel, asphalt and /or petrochemicals. The products
that jointly result from processing a common input are called joint products.
The cost of the input and the joined production process is called a joint product cost. The
point in the production process where the individual products becomes separately identifies is
called the split-off point. An example is the point at which coal becomes coke, natural gas
and other products.
Separable costs or further processing costs are all costs incurred after the split off point
that are assignable to one or other more individual products.
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, that product is known as a main product. A byproduct has a relatively low
sales value compared with the sales value of a joint or main product. Some outputs of the
joint production process have zero sales value. For example, the offshore processing of
hydrocarbons to obtain oil and gas also yields water that is recycled is led back into the
ocean. Similarly, the processing of mineral ore to obtain gold and silver also yield dirt that is
recycled back into the ground.

Objectives of allocating joint costs

The organizations allocate joint costs for many reasons, including measuring performance,
estimating casualty losses, determining and responding to regulatory rates, and specifying
and resolving contractual interests and obligations.
Manufacturing companies are required to use joint cost allocations for financial and tax
reporting to value inventories and cost of goods sold. It is realized that the results of
allocating joint costs in different ways can be very important to management decision-
making.

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(a) Measuring performance:
Joint cost allocations can serve as measures of some departmental or division costs when
executive performance is evaluated. Many companies compensate executives and other
employees, at least partly on the basis of departmental or divisional earnings for the year,
which could be based on allocated joint costs.
Using any cost allocation as a performance measures raises the issue of fairness and could
affect the use of resources or provide the incentive to manipulate the performance measure.

(b) Estimating casualty losses:

Joint cost allocations can be useful in valuing inventory for insurance purposes. If a causality
loss occurs, the insurance company and the insured party must agree on the value of the lost
goods. For example suppose that a portion of the specialty lumber was destroyed at timber
traders place and the cost of the lumber destroyed should include a portion of the joint costs.

(c) Determining and Responding to Regulated Rates

When companies are subject to rate (Price) regulation, the allocation of joint costs can be a
significant factor in the way regulators determine rates. Thus, the manner of allocating and
using joint costs can be important cost drivers in utilities that depend on joint cost allocations
for pricing or reimbursement.

(d) Specifying and Resolving contractual interests and obligations: -

Many contracts involve parties with potentially conflicting interests. Often prices for goods
and services exchanged among contracting parties are based on costs, including allocated
joint costs. Any cost allocation method contains an element of arbitrariness or inexactness
attempts to more accurately assign costs to products. Thus, specifying how to allocate costs in
advance is advisable. Cost management analyses, by estimating the effects of joint cost
allocations and clearly spelling out how to allocate joint costs, contribute to informed
negotiations and a smoothly functioning contractual arrangement.

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Joint cost-Allocation Methods
There are two basic approaches are used to allocate joint costs.
Approach –I Market based data such as revenues:
Three sub methods:
(a) Sales value at split off method
(b) Estimated net realizable value (NRV) method and
(c) Constant gross- margin percentage NRV behold
Approach II: - Physical measure based data, such as weights or volume.
Approach I Market based data method:
(a) Sales value at split off method allocates joint, costs based on the relative sales values of
the joint products at their split off point. This method does not consider additional
processing costs after the split off point. This 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 entrant period. This method exemplifies the
benefits-received criterion of cost allocation (allocated in proportion to their potential
revenues).
Example1. ABC Company manufactures three types of fertilizers in a joined production
process. The production and sales data for April 2010 is given below:
ABC Company
Schedule of production and sales data for the month of April 2010
Items X Y Z Total
Produced & sold 50,000 Bags 25,000 Bags 10,000 Bags 85,000 Bags
Sales price at split- 10 per Bag 15 per Bag 20 per Bag
off point

Cost after split off 100,000 150,000 70,000 320,000

Joint cost 340,000

Compute joint cost to items X, Y, & Z on the basis of sales value at the split off point
method:
Solution: a) Sales value at the split off point method

Item Quantity produced Unit Price Sale value split Joint cost
off point allocated
X 50,000 Bags $ 10 $500,000 $158,140
Y 25,000 Bags $ 15 375,000 118,605
Z 10,000 Bags $ 20 200,000 63,255
85,000 Bags 1,075,000 340,000

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 (b) Estimated net Realizable value (NRV) method:
The estimated net realizable value (NRV) method allocates joint costs to joint products on the
basis of the relative estimated NRV (estimated sales value in the ordinary course of business
minus the expected separable costs) of the total production of these products during the
accounting period. This method 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 not available.
Example-2: Refer Example 1. Allocate joint costs $ 340,000 to joint products on the basis of
Net realizable value (Assuming selling price after further processing is $ 15, 20 and 25
respectively for items X, Y& Z.
Solution:
Items Sales Selling price Sales Further Net realizable Ratio Joint
quantity Per bag after value processing cost value of cost
further NRV
processing
X 50,000 15 bags 750,000 100,000 650,000 65/118 187,288
Y 25,000 20 bags 500,000 150,000 350,000 35118 100,848
Z 10,000 25 bags 250,000 70,000 180,000 18/118 51.864
1,500,000 1,180,000 340,000

(c) Constant gross margin percentage NRV method

Under this method the joint costs are allocated to products in a way that the gross margin
parentages as a percent of revenues are the same for each joint product .The following three
steps are to be followed.
(i) Compute the total gross margin percentage.
(ii) Use the total gross margin percentage calculated in step 1 to calculate the gross
margin for each product (total gross margin percentage & sales value).
(iii) Deduct the additional processing costs from the total costs to calculate joint costs
allowed to each product.
Example 3: ABC Dairy Company purchases raw milk from individual farms and process it
until the split off point, where two products (cream and liquid skim) emerge. These two
products are sold to all independent company, which markets and distributes them to
supermarkets and other retail outlets.
Summary data for July 2003 are as follows:
Raw milk processed 220,000 gallons. Twenty thousand gallons of raw milk are lost in the
production process due to evaporation, spillage and the like yielding 200,000 gallons of good
product.

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Production during the month is as follows
Cream- 50,000 gallons
Liquid- 150,000 gallons
Cost of purchasing and processing it until the split off point, $ 1,600,000
The above production is further processed as follows:
Cream-Butter cream: 50,000 gallons of cream are further processed to yield 40,000gallons of
butter cream at additional processing cost of 1,120,000. Butter cream sold for $ 50 per gallon
is used in the manufacture of butter based products.
Liquid skim Condensed milk: 150,000 gallons of liquid skim are further processed to yield
100,000 gallons of condensed milk at additional processing costs of $ 2,080,000; condensed
milk is sold for $ 44 per gallon.
Required:
Allocate joint cost to joint product under constant Gross-Margin percentage NRV method.
Solution:
Step1: Computation of the overall gross margin percentage.
Expected sales value
40,000 gallons x $ 50 6,400,000
100,000 gallons x 44
Less: joint cost & additional cost
(1,600,000 + 1,120,000 + 2,080,000) 4,800,000
Gross Margin 1,600,000
1,600,00
Gross margin percentage = x100  25%
6,400,000
Step 2: Computation of cost of goods sold:
Butter Cream Condensed Milk Total
Expected sales value $ 2,000,000 4,400,000 6,400,000
40,000 x 50
100,000 x 44
Less Gross margin 500,000 1,100,000 1,600,000
@ 25%
Cost of goods sold 1,500,000 3,300,000 4,800,000

Step 3- Computation of joint cost:

Cost of goods sold 1,500,000 3,300,0000 4,800,000
Less: Additional 1,120,000 2,080,000 3,200,000
costs
Joint cost allocated 380,000 1,220,000 1,600,000

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Approach II Physical measure based data such as weights or volume
The physical measures (or quantities) method is a joint cost allocation based on the relative
volume weight, energy content, or other physical measure of each joint product or other
physical measure of each joint product at the split off point. Companies might prefer the
physical measures method when the prices of their output products are highly volatile or
unpredictable. This method is sometimes used when significant processing occurs between
the split off point and the first sales opportunity, or when the market does not set product
prices. The latter situation could arise when regulators set prices in regulated pricing
situations or in cost based contract situation.

Many oil and gas producing companies allocate joint costs on the basis of the products
energy equivalents. They use this method because the products are typically measured in
different physical units (e.g., natural gas by thousands of cubic feet, oil by barrels) although
oil and natural gas often are produced simultaneously from the same well.

Example 4: Refer example 3 and compute joint allocation on the basis of physical measure
method.

Solution: Computation of joint allocation under physical measure method:

Cream Liquid Cream Total
(i) Physical measure of
production (gallons) 50,000 150,000 2,000,000
(ii) Weighing 0.25 0.75
(iii) Joint cost allocated 400,000 1,200,000 1,600,000
(0.25 x 1,600,000) and
(0.75 x 1,600,000)
(iv) Joint production 400,000 1,200,000
50,000 150,000
Cost per gallon $ 8 per gallon $ 8 per gallon

Accounting for by products

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

Two by-product accounting methods are followed.

Method –A: The production Method:

This method recognizes by products in the financial statements at the time production is
completed. Recognition of byproducts at the time of production is conceptually correct.

Method - B: Sales Method:

The sales method delays recognition of by-products until the time of sale. The recognition at
the time of sales occurs in practice, it is usually rationalized on the grounds that the dollar
amounts of by products are immaterial.
Example:

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Mr. Robert is the owner and operator of coca Bottling, a bulk soft drink producer. A single
production process yields two bulk soft drinks. Rainbow Dew (the main product) and Resi
Dew (the by product). Both products are fully processed at the split off point and there are no
separable costs.
For September 2003, the cost of the soft drink operations is $ 120,000. Production and sales
data are as follows:

Production Sales Selling Price

(in gallons) (in gallons) Per gallon

Main Product: Rainbow Dew 10000 8000 $ 20.00

By Product: Resi Dew 2000 1400 2.00
There were so beginning inventories on September 1, 2003.
Required:
1. What is the Gross Margin for Coca Bottling under Methods A and B of by product
accounting?
2. What are the inventory costs reported in the balance sheet on September 30, 2003, for
Rainbow Dew and Resi- Dew under the two methods of byproducts accounting in
requirement?
3. Pass necessary journal entries under two methods.
Solution
1. Computation of Gross margin for Coca Bottling under Method A and B of by-products
accounting.

By product Accounting Method

Method A Method B
Recognized at Recognized at
Production Sale

Revenue
Main Product: Rainbow Dew $ 160,000 $ 160,000
(8000 x $ 20)
By product: Resi Dew - 2,800
(1400 x $ 2)
Total Revenue 160,000 162,800

Cost of goods sold

Total manufacturing costs 120,000 120, 000
Less: By Product revenue 4,000 -
(2000 x 2)
Net manufacturing costs 116,000 120,000
Less: Main product (a) 23,200 (b) 24,000
Inventory
Cost of goods sold 92800 96,000
Gross margin 67200 66,800
Gross margin percentage 42% 41.03%
116000
(a) x 2000 = 23200.
10,000

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 120,000
(b) x 200 = 24,000
10,000

2 Statement showing inventory cost reported in the balance sheet on Sep

30, 2003.
Method -A Method –B
Inventories costs (as of Sep 30)
Main product: Rainbow Dew: $ 23200 $ 24,000
By product: Resi Dew
(600 x 2) $ 1200 -

3. Journal entries:

Method – A Production Method:

(a) Work in process 120,000

Accounts payable/various account 120,000
(to record direct Materials purchased and
used in production and conversion costs
in the production process during Sep 2003)

(b) By product inventory (Resi Dew) 4000

(2000 x 2)
Finished goods main product 116,000
(120000 – 6,000)
Work in process 120,000

To record cost of goods completed in September 2003.

© (i) Cost of goods Sold (8000  10,000) x116000 92800

Finished goods- main product 92800
To record the cost of the main product
Sold during September 2003

(ii) Cash or accounts receivable 160,000

(8000 x 20)
Revenues – Main product 160,000
(d) Cash or account revenue 2800
(1400 x 2)
By product – inventory 2800
to record the sales of the by product
During September 2003

Method – B (Sales Method)

(a) Work in process 120,000

Accounts payable /various 120,000
Accounts

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(a) Finished goods – main –product 120,000
Work in process 120,000
(To record cost of goods completed during
September 30)

© (i) Cost of goods sold 96000

(8000  10,000) x 120,000
Finished goods Main product 96,000
(To record the cost of main product sold
during September, 2003)

(ii) Cash or Accounts Receivable 160,000

Revenue – Main product 160,000
(To record the saler of main product
during September, 2003)

(d) Cash or Account receivable 2800

(1400 x 2)
Revenues – By product 2800
To record the sales of the by product
during September, 2003.