1

MANAGEMENT ACCOUNTING AND CONTROL

(MNAC)

Session 6
Cost Allocation:
Joint Products and Byproducts

Chapter 16 of Prescribed Text-Book :

Horngren
Learning Objectives (LO 1-5) – Chapter 16

1. Identify the split off point in a joint-cost situation and

distinguish joint products from byproducts
2. Explain why joint costs are allocated to individual products
3. Allocate joint costs using four methods
4. Identify situations where the sales value at split off method is
preferred when allocating joint costs
5. Explain why joint costs are irrelevant in a sell-or-process
further decision
6. Account for byproducts using two methods
 Joint Cost Terminology

• Joint costs—the costs of a production process that yields

multiple products simultaneously.
[Eg. Cost of Distillation of coal which yields coke, natural gas and other
products]

• Split off point—the juncture in a joint production process when two

or more products become separately identifiable.
[Eg. Point at which coal becomes coke, natural gas and other products]

• Separable costs—all costs (manufacturing, marketing, distribution,

and so on) incurred beyond the split off point that are
assignable to each of the specific products identified at the split off
point.
Joint Costs & Separable Costs
 Examples of Joint Cost Situations

• Production processes in many industries simultaneously yields two or more products, either
at the splitoff point or after further processing.
• Joint costing allocates costs to individual products that are eventually sold.
 Joint Cost Terminology

• Categories of joint process outputs:

1. Outputs with a positive sales value.
2. Outputs with a zero sales value

[E.g. Offshore processing of hydrocarbons yields oil and natural gas –

positive sales value and it also yields water – zero sales value and is
recycled back into the ocean]

• Product—any output with a positive sales value, or

an output that enables a firm to avoid incurring costs:
– Sales value can be high or low.
 Joint Cost Terminology

• Main product—output of a joint production process that

yields one product with a high sales value compared to
the sales values of the other outputs.

• Joint products—outputs of a joint production process that

yields two or more products with a high sales value
compared to the sales values of any other outputs.

• Byproducts—outputs of a joint production process that have

low sales values compared to the sales values of the other
outputs.
 Examples of main, joint and byproducts

Timber (Logs) Processed Standard Lumber(main product) High Sales Value

Wood chips (byproduct) Low sales value

Timber (Logs) Processed Fine-grade lumber and Standard Lumber(joint products)

High Sales Value
Wood chips (byproduct) Low sales value
 Why Joint Costs are Allocated
Before a manager is able to allocate joint costs, one must first look at the context for doing so.

Joint costs must be allocated to individual products or services for several purposes, including:

• Computation of inventoriable costs and cost of goods sold for financial accounting and
tax reporting. [Eg .Allocation of joint
manufacturing or processing costs to products necessary for calculating ending inventory values and
also to analyze the profitability of various divisions and in turn evaluate the performance of the division
managers]
• Reimbursing companies that have some, but not all, of their products or services
reimbursed under cost-plus contracts.[ Eg. Government agency]
• Regulating the rates or prices of one or more of the jointly produced products or services.
[ Eg extractive
and energy industries, in which the output process are regulated to yield a fixed return on cost basis. Eg.
In Telecommunications, a firm with significant market power has some products subject to price
regulation and other activities that are unregulated. Joint costs must be allocated to ensure that costs
are not transferred from unregulated services to regulated ones]
• Litigation or insurance settlement situations in which joint costs of products and services
are key inputs.
 Two Approaches to Allocating Joint Costs

1. Physical measures—allocate using tangible attributes of

the products, such as weight, quantity, or volume of the
joint products

2. Market-based—allocate using market-derived data such

as revenues (dollars):
i. Sales value at splitoff method
ii. Net realizable value (NRV) method
iii. Constant gross-margin percentage NRV method
 General points - Allocating Joint Costs

• We had used cause-and-effect and benefits-received criteria for guiding cost-

allocation decisions.

• Joint costs do not have a cause-and-effect relationship with individual

products because the production process simultaneously yields multiple products.
• Under benefits-received criterion leads to the preference for methods under
approach 1 because revenues are in general, a better indicator of benefits
received than physical measures.
• E.g.Mining companies receive more benefits from 1 ton of gold than they do from
10 tons of coal.
• Simplest Joint production process - Joint products are sold at the spilt off without
further processing- approaches are Sales value at splitoff point and the physical
measure method.
• Joint production process that yields products that require further processing
beyond the splitoff point – NRV method and Constant Gross margin percentage
NRV method.
 Joint Cost Illustration- Overview
Example : Overview of Dairy

Mother Dairy purchases raw milk from individual farms and processes it until the splitoff point,
when 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.

20,000
gallons sold
@ $8
Mother Dairy
processes 110,000
gallons of raw milk. Ending Inventory
5,000 gallons
During processing,
10000 gallons are
lost due to 30,000
evaporation and gallons sold
spillage, yielding @ $4
25000 gallons of
cream and 75000
gallons of liquid Ending Inventory
skim, 45,000 gallons
 Joint Cost Example - Data
Example - Overview of Dairy

How much of the $ 400,000 joint costs should be allocated to :

1) The cost of goods sold of 20000 gallons of cream and 30000 gallons of liquid skim
and

2) how much should be allocated to the ending inventory of 5000 gallons of cream and
45,000 gallons of liquid skim.
 1. Physical-Measure Method

The physical-measure method allocates joint costs to joint

products produced during the accounting period on the basis of a
comparable physical measure, such as the relative weight,
quantity, or volume at the split off point.

Obtaining comparable physical measure is not always

straightforward – may require assistance from technical
personnel outside of accounting.

This method is considered less desirable – physical measures

usually have no relationship to the revenue-generating abilities of a
product.
 Physical-Measure Method, Example
Step 1: Joint-Cost Allocation Using Physical-Measure Method: Dairy For May xxxx
Step 2: Product-Line Income Statement Using Physical-Measure Method
 2(i). Sales Value at Split off Method
o The sales value at split off method allocates joint costs to joint
products produced during the accounting period on the basis of the
Relative TSV (total sales value) at the split off point.

o This method uses the sales value of the entire production (25000 gallons of
cream and 75000 gallons of liquid skim) of the accounting period, not just the
quantity sold (20000 gallons of cream and 30000 gallons of liquid skim) - joint costs
were incurred on all units produced and not just on the portion sold.

o The sales value at split off method follows the benefits-received criterion
of cost allocation. [costs are allocated to products in proportion of their revenue-
generating power or expected revenue. Cost allocation base (total sales value at
spiltoff) is expressed in terms of common denominator ie amount of revenue.
o To use this method , selling prices must exist for all products at the
splitoff point.
 Sales Value at Split off, Example

Step 1 : Joint-cost Allocation Using Sales Value at Split off Method

Dairy for May xxxx

Allocated Joint costs to each product in proportion to sales value of total production
cream :160,000/200000 = 80%
Liquid skim: 240000/300000=80%
 Sales Value at Split off, Example

Step 2: Product-Line Income Statement Using Sales Value at Split off Method:
Dairy for May xxxx
 2 (ii). Net Realizable Value (NRV) Method
• Allocates joint costs to joint products produced during the
accounting period on the basis of relative NRV.

• NRV = Final Sales Value – Separable Costs.

• In many cases, products are processed beyond the split

off point to bring them to a marketable form or to increase
their value above their selling price at the split off point.

• NRV method is used in preference to the sales value at

splitoff method only when selling prices for one or more
products at splitoff do not exist.
 Net Realizable Value Method Overview
Example : Overview of Dairy

Cream and liquid skim processed further:

25000 gallons of Cream are further processed to yield 20000 gallons of Buttercream at an additional processing
costs of $280000. Buttercream sells for $25 per gallon and used in the manufacture of butter-cased products

75000 gallons of Liquid skim are further processed to yield 50000 gallons of condensed milk at an additional
processing costs of $520000. Condensed milk sells for $22 per gallon.

Sales were 12000 gallons of buttercream and 45000 condensed milk during this period.
Net Realizable Value Method Example
Extended Data for Dairy Example
 Net Realizable Value Method Example
Joint-Cost Allocation And Product-Line Income Statement Using NRV Method: Dairy For May
xxxx