Cost allocation joint cost [compatibility mode]

COST ALLOCATION –JOINT COST AND BYPRODUCTS

Group Project

RESHMI RAVEENDRAN (212027)

Joint Cost Terminology• Joint Costs – Costs of a single production process that yields multiple products simultaneously.

• Splitoff Point – The place in a joint production process where two or more products become process where two or more products become separately identifiable

• Separable Costs – All costs incurred beyond the splitoff point that are assignable to each of the now-identifiable specific products

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 outputscompared 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 compare to the sales values of the other outputs

Examples of Joint Cost Situations

Joint Process Overview

Reasons for Allocating Joint Costs

• Required for GAAP and taxation purposes

• Cost values may be used for evaluation purposes

• Cost-based Contracting• Cost-based Contracting

• Insurance Settlements

• Required by regulators

• Litigation

Distinction and Similarity Between Joint

Products and By-Products• The distinction between joint products and by-products rests solely on the relative importance of their sales value.

• A by-product is a secondary product whose total sales value is relatively minor in comparison with the sales value of the main relatively minor in comparison with the sales value of the main product (joint product).

• Relationships between joint products and by-products change over time as technology and markets change.

• By-products may become more and more important, eventually becoming joint products.

• When the relative importance of individual products changes, the products need to be reclassified and the costing procedures need to be changed.

Joint Cost Allocation Methods

• Market-Based – allocate using market-derived data (dollars):

1. Net Realizable Value (NRV)1. Net Realizable Value (NRV)

• Physical Measures – allocate using tangible attributes of the products, such as pounds, gallons, barrels, etc

1. The sales value at Splitoff method

2.The Physical-measure method

3. Weighted average

Physical-Measure Method

• Allocates joint costs to joint products on the basis of the relative weight, volume, or other physical measure at the splitoff point of total physical measure at the splitoff point of total production of the products

Joint Cost Illustration Data

Joint Cost Illustration Overview

Physical Measures Illustration

Weighted Average Method

• The weighted average method uses the weight factors to include such diverse elements as amount of material used, difficulty to manufacture, time consumed, difference in type of labor used, and size of unit.size of unit.

Weighted physical units = Number of units × Weight factor

Example: The canning industry uses weight factors to distinguish between can sizes or quality of product. The weighted average method allocates relatively more of the joint cost to the high-grade products because they represent more desirable and profitable products.

Sales Value at Splitoff Point Method

• Uses the sales value of the entire production of the accounting period to calculate allocation percentage

• The cost-allocation base (total sales value at splitoff) is • The cost-allocation base (total sales value at splitoff) is expressed in terms of a common denominator (the amount of revenues) that is systematically recorded in the accounting system. To use this method, selling prices must exist for all products at the splitoff point

Joint Cost Illustration Data

Joint Cost Illustration Overview

Sales Value at Splitoff Illustration

Net Realizable Value Method

• Allocates joint costs to joint products on the basis of relative NRV of total production of the joint productsjoint products

• NRV = Final Sales Value – Separable Costs

Sell-or-Process Further Flowchart

Net Realizable Value Method Overview

Net Realizable Value Method Illustrated

Net Realizable Value Method Illustrated

Method Selection

• If selling price at splitoff is available, use the Sales Value at Splitoff Method

• If selling price at splitoff is not available, use the NRV method

• If selling price at splitoff is not available, use the NRV method

• If simplicity is the primary consideration, Physical-Measures Method.

• Despite this, some firms choose not to allocate joint costs at all

Byproducts• Byproducts have low sales value and some times their salvage value is not considered.

• Two methods for accounting for byproducts• Production Method –i) Recognizes byproduct inventory as it is created,i) Recognizes byproduct inventory as it is created,ii) Byproduct revenues appear in the income statement as Cost reduction for the main product

• Sales Method –i) Recognizes only sales at the time of sales,ii) Byproduct revenues appear in the income statement as Separate item of revenue or other income

Accounting for Byproducts

Neither approach is conceptually correct.

Both technically violate GAAP.• Method A- Production method• Method A- Production method

• Recognizes byproducts revenue

at the time their production is completed.

• Method B: Sales method

Does not recognize byproducts in inventory.

Byproducts Illustration Overview

The Westlake Corporation processes timber into fine-grade lumber and wood chips that are used as mulch in gardens and lawns. Information about these products follows:Fine-Grade lumber (the main product)—sells for $6 per board foot (b.f.) Wood chips (the byproduct)—sells for $1 per cubic foot (c.f.) Data for July 2012 are as follows

Beginning production

production sales Ending inventoryproduction inventory

Fine-Grade lumber

0 50,000 40,000 10,000

Wood chips

0 4,000 1,200 2,800

Comparative Income Statements for Accounting for Byproducts

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