Cost Allocation: Joint Products and Byand By--productsproducts · Joint Products and ByJoint Products and By-products A byA by--product has a relatively low sales value product has

Cost Allocation: Joint Products Cost Allocation: Joint Products and Byand By--productsproducts

ACCT7320ACCT7320Dr. BaileyDr. BaileyDr. BaileyDr. Bailey

Tuesday, September 29, 2009Tuesday, September 29, 2009

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Nature of Cost AllocationsNature of Cost AllocationsNature of Cost AllocationsNature of Cost Allocations

Pervasive in accountingPervasive in accounting–– Across time (depreciation)Across time (depreciation)Across time (depreciation)Across time (depreciation)–– Between departments (e.g., service Between departments (e.g., service deptsdepts))

T d b h ffiT d b h ffi–– To products, customers, branch offices, etc.To products, customers, branch offices, etc.Often arbitraryOften arbitrary–– May mislead in decision makingMay mislead in decision making

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Criteria to GuideCriteria to GuideCostCost--Allocation DecisionsAllocation DecisionsCostCost--Allocation DecisionsAllocation Decisions

Cause-and-effect:Using this criterion, managers identify thevariable or variables that cause resources

to be consumed.Benefits-received:Benefits received:

Using this criterion, managers identify thebeneficiaries of the outputs of the cost object.

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beneficiaries of the outputs of the cost object.

Criteria to GuideCriteria to GuideCostCost--Allocation DecisionsAllocation DecisionsCostCost--Allocation DecisionsAllocation Decisions

Fairness or equity:This criterion is often cited on governmentThis criterion is often cited on government

contracts when cost allocations are the basisfor establishing a price satisfactory to thefor establishing a price satisfactory to the

government and its suppliers.Abilit t bAbility to bear:

This criterion advocates allocating costs in proportiont th t bj t’ bilit t b th

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to the cost object’s ability to bear them.

Role of Dominant CriteriaRole of Dominant CriteriaRole of Dominant CriteriaRole of Dominant Criteria

The cause-and-effectand the benefits- F i d bilia d t e be e tsreceived criteria

guide most

Fairness and abilityto bear are lessf tl dg

decisions relatedto cost allocations.

frequently used.Why?y

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Role of Dominant CriteriaRole of Dominant CriteriaRole of Dominant CriteriaRole of Dominant Criteria

Fairness is an especially difficult criterionto obtain agreement on.

The ability to bear criterion raises issuese b y o be c e o ses ssuesrelated to cross-subsidization across users

of resources in an organization.g

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Joint CostsJoint CostsJoint CostsJoint Costs

This “joint cost” problem arises when This “joint cost” problem arises when companies inescapably produce two or more companies inescapably produce two or more p p y pp p y pproducts simultaneously out of the same products simultaneously out of the same process.process.ppHow do they allocate costs to jointlyHow do they allocate costs to jointly--produced produced productsproductsproducts.products.How are the resulting allocations useful?How are the resulting allocations useful?

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JointJoint--Cost BasicsCost BasicsJointJoint--Cost BasicsCost Basics

Joint costs Joint costs are the costs of a single production are the costs of a single production process that yields multiple products process that yields multiple products p y p pp y p psimultaneously.simultaneously.Industries abound in which a singleIndustries abound in which a singleIndustries abound in which a single Industries abound in which a single production process simultaneously yields two production process simultaneously yields two or more productsor more productsor more products.or more products.

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Tomatoes

Tomato juice Tomato sauce Tomato pastej p

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Coal

Gas Benzol Tar

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The outputs of a joint production process fall The outputs of a joint production process fall into two general categories:into two general categories:g gg g

11 Joint productsJoint products——those that the company is in those that the company is in business to produce (higher total value)business to produce (higher total value)business to produce (higher total value)business to produce (higher total value)

22 ByBy--productsproducts——those that also emerge (lesser those that also emerge (lesser value)value)value)value)

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Splitoff PointSplitoff PointSplitoff PointSplitoff Point

The The splitoff point splitoff point is the juncture in the is the juncture in the production process where one or more production process where one or more p pp pproducts in a jointproducts in a joint--cost setting become cost setting become separately identifiable.separately identifiable.p yp ySeparable costs Separable costs are all costs (manufacturing, are all costs (manufacturing, marketing distribution etc ) incurred beyondmarketing distribution etc ) incurred beyondmarketing, distribution, etc.) incurred beyond marketing, distribution, etc.) incurred beyond the splitoff point that are assignable to one or the splitoff point that are assignable to one or more individual productsmore individual products

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more individual products.more individual products.

Joint Products and ByJoint Products and By--productsproductsJoint Products and ByJoint Products and By--products products

Joint products Joint products have relatively high sales value have relatively high sales value at the splitoff point.at the splitoff point.p pp p–– Main product Main product is the result of a joint is the result of a joint

production process that yields only oneproduction process that yields only oneproduction process that yields only one production process that yields only one product with a relatively high sales value.product with a relatively high sales value.

ByBy productsproducts are incidental products resultingare incidental products resultingByBy--productsproducts are incidental products resulting are incidental products resulting from the processing of another product.from the processing of another product.

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Joint Products and ByJoint Products and By--productsproductsJoint Products and ByJoint Products and By--productsproducts

A byA by--product has a relatively low sales value product has a relatively low sales value compared with a joint or main product.compared with a joint or main product.p j pp j p–– Revenue from byproducts generally reduces Revenue from byproducts generally reduces

the costs of the joint products We aren’tthe costs of the joint products We aren’tthe costs of the joint products. We aren t the costs of the joint products. We aren t studying the details.studying the details.

Some outputs of the joint production processSome outputs of the joint production processSome outputs of the joint production process Some outputs of the joint production process have zero sales value.have zero sales value.

“W ”“W ” b i d i ib i d i i15 - 14

–– “Waste” “Waste” cancan be ignored in accountingbe ignored in accounting


Main orJoint Products By-productsy p

High Low

Sales Value

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To reiterate: To reiterate: sales valuesales value determines the determines the classificationclassificationProducts can change from byProducts can change from by--products to joint products to joint products when their relative sales valuesproducts when their relative sales valuesproducts when their relative sales values products when their relative sales values increases, and viveincreases, and vive--versaversa

Kerosene once main product of petroleumKerosene once main product of petroleum–– Kerosene once main product of petroleumKerosene once main product of petroleum

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Why Allocate Joint Product Costs?Why Allocate Joint Product Costs?Why Allocate Joint Product Costs?Why Allocate Joint Product Costs?

The purposes for allocating joint costs to products The purposes for allocating joint costs to products include:include:

11 Inventory costing Inventory costing –– Important for financial accounting purposes, reports to income tax Important for financial accounting purposes, reports to income tax

authorities and internal reporting purposesauthorities and internal reporting purposesauthorities, and internal reporting purposes.authorities, and internal reporting purposes.

22 Cost reimbursement contractsCost reimbursement contracts–– Cost allocation is required for cost reimbursement purposes under Cost allocation is required for cost reimbursement purposes under q p pq p p

contracts when only a portion of a business’ products or services is contracts when only a portion of a business’ products or services is sold or delivered to a single customer (government agency).sold or delivered to a single customer (government agency).

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Why Allocate Joint Product Costs?Why Allocate Joint Product Costs?Why Allocate Joint Product Costs?Why Allocate Joint Product Costs?

33 Insurance settlementsInsurance settlements»» Require cost allocation when damage/loss claims made Require cost allocation when damage/loss claims made q gq g

by manufacturer: What was the “cost”?by manufacturer: What was the “cost”?

44 Rate regulationRate regulation»» If one or more of the jointly produced products or If one or more of the jointly produced products or

services are subject to price regulation (nat. gas).services are subject to price regulation (nat. gas).

5.5. LitigationLitigation»» Joint cost allocation is important in litigation Joint cost allocation is important in litigation

i l i j i t d ti l i j i t d t

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involving one or more joint products.involving one or more joint products.

How to Allocate Joint Costs?How to Allocate Joint Costs?How to Allocate Joint Costs?How to Allocate Joint Costs?

The two basic approaches to allocating joint The two basic approaches to allocating joint costs are:costs are:–– Use marketUse market--based data such as relative based data such as relative

product revenuesproduct revenuesproduct revenues.product revenues.»» “Sales value at splitoff”“Sales value at splitoff”»» “Estimated net realizable value”“Estimated net realizable value”

–– Use physical measures such as weight or Use physical measures such as weight or volumevolume

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volume.volume.

Allocating Joint CostsAllocating Joint CostsAllocating Joint CostsAllocating Joint Costs

Lubbock Company incurred $200,000 of joint Lubbock Company incurred $200,000 of joint costs to produce the following:costs to produce the following:p gp gProduct A: 10,000 units, 20,000 pounds Product A: 10,000 units, 20,000 pounds Product B: 10 500 units 48 000 poundsProduct B: 10 500 units 48 000 poundsProduct B: 10,500 units, 48,000 poundsProduct B: 10,500 units, 48,000 poundsProduct C: 11,500 units, 12,000 poundsProduct C: 11,500 units, 12,000 pounds

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Sales Value at Splitoff MethodSales Value at Splitoff MethodSales Value at Splitoff MethodSales Value at Splitoff Method

Allocates joint costs to joint products on the Allocates joint costs to joint products on the basis of the relative total sales value at the basis of the relative total sales value at the splitoff point.splitoff point.–– All outputs mustAll outputs must havehave sales values at thissales values at thisAll outputs must All outputs must havehave sales values at this sales values at this

point to use the method.point to use the method.

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Assume the following sales values per unit: A: $10.00, B: Assume the following sales values per unit: A: $10.00, B: $30.00, and C: $20.00$30.00, and C: $20.00Wh i hWh i h ll l l li ff i ?l l li ff i ?What is the What is the totaltotal sales value at splitoff point?sales value at splitoff point?Product A: 10,000 Product A: 10,000 ×× $10.00 =$10.00 = $100,000$100,000 15.5%15.5%Product B: 10 500Product B: 10 500 ×× $30 00 =$30 00 = 315 000315 000 48 8%48 8%Product B: 10,500 Product B: 10,500 ×× $30.00 =$30.00 = 315,000315,000 48.8%48.8%Product C: 11,500 Product C: 11,500 ×× $20.00 =$20.00 = 230,000230,000 35.7%35.7%TotalTotal $645,000$645,000 100%100%$ ,$ ,

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How much joint costs are allocated to each How much joint costs are allocated to each product?product?ppA: 15.5%A: 15.5%×× $200,000 = $ 31,008 $200,000 = $ 31,008 B: 48 8%B: 48 8% ×× $200 000 = 97 674$200 000 = 97 674B: 48.8% B: 48.8% ×× $200,000 = 97,674$200,000 = 97,674C: 35.7% C: 35.7% ×× $200,000 = $200,000 = 71,318 71,318 TotalTotal $200,000$200,000

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What are the joint production costs per unit?What are the joint production costs per unit?Product A: $31 008Product A: $31 008 ÷÷ 10 000 = $3 1010 000 = $3 10Product A: $31,008 Product A: $31,008 ÷÷ 10,000 $3.1010,000 $3.10Product B: $97,674 Product B: $97,674 ÷÷ 10,500 = $9.3010,500 = $9.30P d C $71 318P d C $71 318 11 500 $6 2011 500 $6 20Product C: $71,318 Product C: $71,318 ÷÷ 11,500 = $6.2011,500 = $6.20

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Assume all of the units produced of B and C Assume all of the units produced of B and C were sold (no further processing).were sold (no further processing).( p g)( p g)2,500 units of A (25%) remain in inventory.2,500 units of A (25%) remain in inventory.What is the gross margin percentage of eachWhat is the gross margin percentage of eachWhat is the gross margin percentage of each What is the gross margin percentage of each product?product?

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Product A Product A Revenues: 7 500 unitsRevenues: 7 500 units ×× $10 00$10 00 $75 000$75 000Revenues: 7,500 units Revenues: 7,500 units ×× $10.00$10.00 $75,000$75,000Cost of goods sold:Cost of goods sold:

J i d $31 008J i d $31 008–– Joint product costs $31,008Joint product costs $31,008–– Less ending inventory Less ending inventory 7,752*7,752* 23,25623,256

»» *$31,008 *$31,008 ×× 25%25%

Gross marginGross margin $51,744$51,744

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Prod. A: $75,000 Prod. A: $75,000 –– $ 23,256 = $51,744; $ 23,256 = $51,744; $51,744 $51,744 ÷÷ $75,000 = 69%$75,000 = 69%

Prod. B: ($315,000 Prod. B: ($315,000 –– $97,674) $97,674) ÷÷ $315,000 = 69%$315,000 = 69%Prod. C: ($230,000 Prod. C: ($230,000 –– $71,318) $71,318) ÷÷ $230,000 = 69%$230,000 = 69%

The The sales value at splitoff methodsales value at splitoff methodp ffp ffproduces an identical gross margin produces an identical gross margin percentage for each product.percentage for each product.

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p g pp g p

Estimated Net Realizable Value Estimated Net Realizable Value (NRV) M th d(NRV) M th d(NRV) Method(NRV) Method

Often products are processed further beyond Often products are processed further beyond the splitoff point to make them marketable or the splitoff point to make them marketable or p pp pincrease their value.increase their value.

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Estimated Net Realizable Value Estimated Net Realizable Value (NRV) M th d(NRV) M th d(NRV) Method(NRV) Method

The estimated The estimated NRVNRV method allocates joint method allocates joint costs to joint products on the basis of the costs to joint products on the basis of the j pj prelative estimated relative estimated NRVNRV..NRVNRV = (expected= (expected final sales valuefinal sales value in thein theNRVNRV (expected (expected final sales valuefinal sales value in the in the ordinary course of business) ordinary course of business) –– (expected (expected separable costsseparable costs of the total production ofof the total production ofseparable costsseparable costs of the total production of of the total production of these products)these products)

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Absolute Irrelevance of Joint Absolute Irrelevance of Joint C t f D i i M kiC t f D i i M kiCosts for Decision MakingCosts for Decision Making

Joint costs incurred up to the splitoff point are Joint costs incurred up to the splitoff point are past (sunk) costs irrelevant to the decision to past (sunk) costs irrelevant to the decision to p ( )p ( )sell a joint (or main) product at the splitoff sell a joint (or main) product at the splitoff point or to process it further.point or to process it further.p pp p

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Irrelevance of Joint Costs for Irrelevance of Joint Costs for D i i M kiD i i M kiDecision MakingDecision Making

Assume that products A, B, and C can be sold Assume that products A, B, and C can be sold at the splitoff point (at at the splitoff point (at price1price1) or processed ) or processed p p (p p ( pp ) p) pfurther into further into A1A1, , B1B1, and , and C1C1 and sold at and sold at price2price2..UnitsUnits price1price1 price2price2 Add’lAdd’l costscostsUnitsUnits price1price1 price2price2 Add lAdd l costscosts

10,000 A: $1010,000 A: $10 A1A1: $12: $12 $35,000$35,00010 500 B $3010 500 B $30 B1B1 $33$33 $46 500$46 50010,500 B: $3010,500 B: $30 B1B1: $33: $33 $46,500$46,50011,500 C: $2011,500 C: $20 C1C1: $21: $21 $51,500$51,500

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Should A, B, or C be sold at the splitoff Should A, B, or C be sold at the splitoff point or processed further?point or processed further?Product A: Incremental revenue $20,000 Product A: Incremental revenue $20,000 –– Incremental cost $35,000 = ($15,000)Incremental cost $35,000 = ($15,000)Product B: Incremental revenue $31,500 Product B: Incremental revenue $31,500 –– Incremental cost $46,500 = ($15,000)Incremental cost $46,500 = ($15,000)Product C: Incremental revenue $11,500 Product C: Incremental revenue $11,500 –– Incremental cost $51,500 = ($40,000)Incremental cost $51,500 = ($40,000)

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Products A, B, and C should be sold at the Products A, B, and C should be sold at the splitoff point.splitoff point.p pp pNo techniquesNo techniques for allocating jointfor allocating joint--product product costs can guide decisions about whether acosts can guide decisions about whether acosts can guide decisions about whether a costs can guide decisions about whether a product should be sold at the splitoff point or product should be sold at the splitoff point or processed beyond splitoffprocessed beyond splitoffprocessed beyond splitoff.processed beyond splitoff.

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The EndThe EndThe EndThe End

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Documents

Cost Allocation: Joint Products and Byand By--productsproducts · Joint Products and ByJoint Products and By-products A byA by--product has a relatively low sales value product has