Joint Products & By Products Costing

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 Concept: Joint Products & By Products
2

Joint products and By-products arise in situations where the

production of one product makes inevitable the production of
other products.

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 Production process for Joint
and by-products
3

When a group of
individual products
is simultaneously
produced, and each
1. Joint products are not identifiable as different individual product has a
products until split- off point. Therefore, joint costs significant relative
cannot be traced to individual products. sales value, the
outputs are usually
called joint products.
2. By- products emerge incidentally from the production
of the major products and have relatively minor sales
 Joint Costs
4

 Joint costs were described by Billera et al, (1981)

as ", costs which cannot be readily identified with
individual products,"

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 Joint Costs
5

Joint products are not identifiable as

different individual products until
split- off point. Therefore, joint costs
cannot be traced to individual
products.

Group of individual products is

simultaneously produced, & each product
has a significant relative sales value,

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 Joint Costs
6

Petroleum refinery:
Diesel is a joint
product when
petroleum is
produced.

 Joint costs arise in extractive,

agricultural & chemical industries, as
well as in industries where different 12/26/22
grades of the same product are obtained.
 Analyst’s Point
7

When processing a sawlog, four main product groups

are produced: center boards, side boards, chips,
and sawdust.
In this kind of joint production it is difficult to
determine raw material costs for the individual
products.
Joint cost accounting can be used to allocate
raw material costs and thus provide information that
is crucial when evaluating profitability in sawmilling.
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 Examples-Joint Costs Situation
8

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 Sawmilling industry: An
Example
9 Research: FOREST PRODUCTS JOURNAL (2008) VOL, 58, NO, 3, 77-
84
 When processing a sawlog, four product groups
will be produced:
1. Center boards (= 40 percent),
2. Side boards (15 percent),
3. Chips (35 percent), and
4. Sawdust (5 percent). In addition, kiln and drying results in
5 percent reduced production volume.
Note: Center boards and side boards are referred to as main
products while chips and sawdust are considered low-value
products and are referred to as by-products.
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 By-products
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A. By-products are any saleable or usual value

incidentally produced in addition to the main
product. (Sawdust is a byproduct of the lumber industry)
B. By-products- sales value is small when compared
with the sales value of joint products.
C. By-products are incidental.
D. By-products do not usually influence the decision as
to whether or not to produce the main product, and
have little effect on the pricing of the main (joint)
product. 12/26/22
 By-products
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 Distinction between joint product
and By-product.
12

1. Extra Expenses: Generally in case of by-products

no extra expenses is to be incurred before the
products can be sold. Where as in case of joint
product additional expenditure will be necessary
before the products can be sold.
2. Importance: If the various products are of
substantial importance they are termed as joint
products. Relatively unimportant products i.e.
molasses and bagasse in a sugar factory are
the case of by-product. 12/26/22
 Example
13

Concept of split-off-point:-
 The distinguishing feature of the production of joint and by-
products is that the products are not identifiable as different
individual products until a specific point in the production
process is reached, known as the split-off-point.

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 Implication
14

Before the split off point,

costs cannot be traced to particular products.
After the split-off point
joint products may be sold or subject to further
processing.

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 WHY JOINT COSTS NEED TO BE
APPORTIONED
15

If the costing system does not capture the

consumption of resources by products, costs
will be distorted and there is a risk that
managers decide to produce unprofitable
products.

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 Application
16

 Joint costs as a component of cost accounting are becoming more

and more important as companies in a variety of industries join
pre-existing firms manufacturing joint cost based products such as
oil, beef, chemicals, etc.

 Industries that produce both joint and by-products-

Chemicals, oil refining, mining, flour milling, and gas
manufacturing.

 The purpose of joint cost allocation has been to attribute joint costs to major
product lines for the purposes of meeting financial reporting requirements.

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 Methods of apportioning
joint costs to products
17

 If all the production for a particular period was sold,

the problem allocating joint costs to products for
inventory valuation and profit measurement would
not exist.
 Calculation of profit would merely require the

deduction of total cost from total sales.

 However, if inventories are in existence at the end of

the period , cost allocation to products are necessary.

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 Methods of apportioning
joint costs to products
18

 The methods used to apportion joint costs are based on

physical volume and sales value of products.
1. Physical volume method: This method assumes to measure benefits
received from the joint product costs by the individual products based on
physical measure i.e. weights, volume.
2. Market value of products method: Methods assumed to measure
the ability to absorb joint costs based on allocating joint costs relative to
the market values of the products.
a. Where by-products are of small value:
b. Where by-products are of considerable value:
c. Where Joint products require further expenditure

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 Example:
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 Products X,Y,and Z all become finished products at the split-off

point. Joint costs for the period Rs.60, 000
Output and sales are as follows:
X = 4000 units at £.7.50
Y = 2000 units at £.25
Z = 6 000 units at £.3.33

There are no further processing costs after split-off point. Show

apportionment of Joint Costs on basis of physical volume and
market value method.
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 Estimation
20

In ratio of 4:2:6 4000x7.5

relative to the market values

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 Implication
21

 Allocation of joint costs bears no relationship to the

revenue producing power of the individual products.
 Product Z – allocated with highest share of joint costs,
but has the lowest total sales revenue. Opposite is the
case for product Y.
 Joint products must be measurable by the same unit of
measurement.
 Joint products will be processed individually beyond
split-off point and market values may not exists for the
products at this stage.
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 CLASS EXERCISE 1
22

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 Points to ponder in apportioning
joint costs to products
23

 The methods used to apportion joint costs are based on

physical volume and sales value of products.
1. Physical volume method: This method assumes to measure benefits
received from the joint product costs by the individual products based on
physical measure i.e. weights, volume…..DONE
2. Market value of products method: Methods assumed to measure the
ability to absorb joint costs based on allocating joint costs relative to the
market values of the products.
 Sale Value at Split Off (SEEN)

 Net Realizable Value Method (NRV)

 Constant Gross Profit Percentage Method

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 A : Where by-products are of small value
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 The effort to calculate their costs is not warranted.

Hence either:
1) The amount realized (or realizable) may be treated
as pure profit and credited to the costing profit and
loss account.
2) The amount realized (or realizable) may be credited

to the cost of main product, thus reducing the cost.

This method is preferable.

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 B : Where by-products have
25
considerable value
 Attempt to find out the cost of each product will be
necessary and justified. The total must be
apportioned between all products (main and by-
products).

 This will require technical knowledge. Merely to

divide the total cost by the number of units of all
products will be defective.

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 C. Where Joint products require
further expenditure
26

 Such additional expenditure should be added

after apportioning joint expenses.

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 Net Realizable Value (NRV) Method
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Generally we assume that all products are sold at the split-off point and that no additional
costs are incurred beyond that point.

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 Net Realizable Value (NRV) Method
28

In practice, it is likely that Joint products will be processed individually beyond

split-off point and market values may not exists for the products at this stage.

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 Implication
29

 To estimate the sales value at split-off point, it is therefore

necessary to use the estimated sales value at the point of
sale and work backwards. This method is called Net
Realizable Value (NRV) Method.
 The NRV at split-off point can be estimated by deducting
from the sales revenues the further processing costs at the
point of sale.
Refer-Excel -Exa-1

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 Constant Gross Profit
Percentage Method
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 Based on the assumption that the gross profit

should be identical for each product.
 Joint costs are therefore allocated so that the

gross profits at split-off point are identical

for each product.

Refer Excel Example-2

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 CLASS EXERCISE
2
31

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32

CLASS EXERCISE
3

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CLASS EXERCISE 4

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 Empirical observation
34

 A survey of UK chemical and oil refining

companies by Slatter and Wootton (1984) reported
the following methods of allocating joint costs.
%
1. Physical measures method 76

2. Sales value method 5

3. Negotiated basis 19

4. Others 14
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 Country practice
35

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 Industry practice
36

 The analysis by industry indicated that the

following methods were used.

Type of Company Predominant cost allocation method used

1. Petrochemicals Sales value at split-off point or Net Realizable
Method
2. Coal Processing Physical Measures Methods
3. Coal Chemicals Physical Measures Methods

4. Oil refining No Allocation of joint costs.

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 Relevant costs for decision-making
Joint cost allocations are necessary for financial accounting, but they should not be
used for decision-making.

Example
Joint product costs £100 000
Sales value at split-off point:
Product X (5 000 units at £16) £80 000
Product Y (5 000 units at £8) £40 000
If additional costs of £6 000 are incurred on product Y it can be converted into
product Z and sold for £10 per unit.

Note that the joint costs are irrelevant for this decision since they will be
incurred irrespective of which decision is taken.

The decision should be based on a comparison of relevant

costs with relevant revenues:
10-8

Relevant revenues (additional revenues of 5 000 × £2) £10 000

Relevant costs (additional costs of processing) 6 000
37 Additional profit from conversion 4 000
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 Managerial Implication
38

 Joint-cost allocations are thus irrelevant for

decision making

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 Case:
39

The Adriatic company incurs joint product costs of $ 10,00,000

for the production of two joint products, X, and Y. Both
products can be sold at split-off point. However, if additional
costs of 60,000 $ are incurred on product Y then it can be
converted into product Z and sold for $10 per unit. The joint
costs and the sales revenue at split-off point are as follows:
X- 50,000 units @$16 per unit
Y-50,000 units @ $8 per unit.
Total revenue = $12,00,000
You are requested to advise management whether or not
product Y should be converted into product Z.
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 Evaluation
40

Convert to product Z Do not Convert

$ $
Sales 13,00,000 12,00,000
Total Cost 10,60,000 10,00,000
Profits 2,40,000 2,00,000

The general rule is that it will be profitable to extend the processing of joint
product so long as the additional revenues exceed the additional costs, but
note that the variable portion of the joint costs will be relevant for
decisions.

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