CHAPTER 16 COST ALLOCATION: JOINT PRODUCTS AND BYPRODUCTS LEARNING OBJECTIVES Identify the splitoff point in a joint-cost situation Distinguish joint products from byproducts Explain why joint costs should be allocated to individual products Allocate joint costs using several different methods Explain why the sales value at splitoff method is preferred when allocating joint costs Explain why joint costs are irrelevant in a sell-or-process-further decision Account for byproducts using two different methods CHAPTER OVERVIEW Chapter 16 continues the study of cost allocation The focus of the allocation is different The cost to be allocated is incurred to identify the individual products rather than to manufacture or produce them The production processing results in the individual products along with other output The distinction, then, needs to be made between output and product: output is anything that comes from processing a material into its component parts whereas a product is output with a positive sales value—revenue will exceed processing costs Basic terms are identified and explained at the beginning of the chapter The reasons why joint costs are allocated are noted for giving purpose to the process Most of the reasons cited relate to measuring income and assets for reporting purposes or to justifying reimbursement Due to the nature of this type of allocation, the criterion of cause and effect has no meaning The criterion of benefits received is preferred and is exemplified through the market-based data methods Revenues are considered the better indicator of benefits than are physical measures The major portion of the chapter is used for illustrating the four methods typically employed to allocate joint costs: sales value at splitoff, physical measure, estimated net realizable value (NRV), and constant gross-margin percentage NRV Diagrams are used extensively to provide example of concepts The text theme of “different costs for different purposes” is highlighted in examining decisions of whether to sell at splitoff point or to further process a product For those decisions, the allocation of joint costs is irrelevant The accounting methods for byproducts is explained and illustrated at the end of the chapter CHAPTER OUTLINE I Costing joint products A Basics [Exhibit 16-1] Joint costs: costs of production process that yields multiple products simultaneously Learning Objective 1: Identify the splitoff point in a joint-cost situation Splitoff point: juncture in joint production process when two or more products become separately identifiable Separable costs: all costs (manufacturing, marketing, distribution, etc.) incurred beyond the splitoff point that are assignable to each of the specific products identified at splitoff point B Focus of joint costing Assigning costs to individual products at splitoff point Classifying outputs by sales value a Product: any output with positive net sales value (enables organization to avoid incurring costs) Learning Objective 2: Distinguish joint products from byproducts b Main product: yield of joint production process of only one product with high sales value compared with other products of process c Joint product: yield of two or more products with high sales value compared to other products of process d Byproduct: low sales value compared with sales value of main or joint products e Some output has zero sales value [Exhibit 16-2] f Some output has negative sales value [Footnote 1] Changing values of products over time and distinctions of terms in organizations Learning Objective 3: Explain why joint costs should be allocated to individual products C Purposes for allocating joint costs Computation of inventoriable costs and cost of goods sold for financial accounting purposes and reports for income tax authorities 216 Chapter 16 Computation of inventoriable costs and cost of goods sold for internal reporting purposes, used in division profitability analysis and affect evaluation of division managers’ performance Cost reimbursement under contracts for companies that have few, but not all, of products or services reimbursed under cost-plus contracts Insurance-settlement computations for damage claims made on basis of cost information by company having joint products, main products, or byproducts Rate regulation for one or more of the jointly produced products or services are subject to price regulation Litigation in which costs of joint products are key inputs Other reasons Learning Objective 4: Allocate joint costs using four different methods D Approaches to allocating joint costs Market-based data, such as revenues, used as basis of allocation a Sales value at splitoff method b Net realizable value (NRV) method c Constant gross-margin percentage NRV method Physical measures data, such as weight or volume, of joint products Learning Objective 5: Explain why the sales value at splitoff method is preferred when allocating joint costs E Criterion to support use of market-based data as basis of joint cost allocation Cause-and-effect criterion not applicable by definition at individual product level Benefits-received criterion: revenues better indicator of benefits received than physical measures F Illustrations in production settings of joint cost allocation methods [Exhibits 16-3 and 16-6 for symbols used] Example 1: Simplest production setting in which joint products sold at splitoff point without further processing a Sales value at splitoff method Cost Allocation: Joint Products and Byproducts 217 i Allocates joint costs to joint products on basis of relative total sales value at the splitoff point of total production of these products during the accounting period ii Assigns a weighting to each product which is percentage of total sales value iii Uses sales value of entire production of accounting period because joint costs incurred on all units produced, not just those sold in period iv Enables product-line income statements to show individual product costs and grossmargins [Refer to Exhibit 16-4] v Follows benefits-received criterion of cost allocation—costs allocated to products in proportion to their potential revenues vi Requires and uses market demand and selling prices for all products at splitoff point —straightforward and intuitive b Physical-measure method i Allocates joint costs to joint products on basis of relative weight, volume, or other physical measure at splitoff point ii Uses total production of the products during the accounting period, not just those sold in period iii Enables product-line income statements to show individual product costs and grossmargins [Refer to Exhibit 16-5] iv Has no relationship to the revenue-producing power of the individual product, hence no relationship to benefits-received criterion v May require assistance from technical personnel outside of accounting because comparable physical measures for all products not always straightforward vi Affects resulting allocation by choice of products to include in physical measure computation as some output has zero sales value—general guideline: include only joint-products outputs in theweighting computations Example 2: Products processed beyond the splitoff point to bring to marketable form or to increase their value above their selling price at splitoff point [Exhibit 16-6] a Net realizable value (NRV) method i Allocates joint cost to joint products on the basis of the relative NRV (final sales value minus the separable costs) ii Uses total production of products during the accounting period, not just those sold in the period 218 Chapter 16 iii Enables product-line income statements to show individual product costs and gross margins [Exhibit 16-7] iv Substitutes for sales value at splitoff method when market selling prices for one or more products not available v Uses simplifying assumptions because companies frequently change the number of subsequent steps beyond the splitoff point or if selling prices of joint products vary frequently vi Exemplifies the benefits-received criterion of cost allocation b Constant gross-margin percentage NRV method i Allocates joint costs to joint products in such a way that overall gross-margin percentage is identical for individual products ii Entails three steps: [Exhibit 16-8] • Step 1: Compute the overall gross-margin percentage for all joint products taken together (use final sales of total production, not the total sales of the period) • Step 2: Multiply overall gross-margin percentage and final sales values of each product to calculate gross margin for each product, subtract gross margin for each product from final sales value of each product to obtain total costs that each product will bear • Step 3: Deduct the separable costs from the total costs that each product will bear to obtain the joint-cost allocation iii Allocates negative amounts to some products to bring their gross-margin percentage up to overall average iv Enables product-line income statements to show individual product cost and grossmargins—overall gross-margin percentage identical for each of the individual products [Exhibit 16-9] v Is different from other market-based methods in it is both a joint cost and a profit allocation method Do multiple choice – Assign Exercises 16-16, 18, and 20, and Problems 16-26 and 16-2.7 G Choosing a method Use sales value at splitoff method when selling-price data available (even if further processing done) a Measures the value of the joint product immediately at end of joint process—best measure of benefits received relative to other methods of allocating joint costs Cost Allocation: Joint Products and Byproducts 219 b No anticipation of subsequent management decisions as required by NRV and constant gross-margin percentage NRV methods i Information required on specific sequence of further processing decisions ii Information required on the point at which individual products are sold c Availability of meaningful basis to allocate joint costs to products i Market-based measures have meaningful basis (revenues) ii Physical measures methods lack meaningful basis d Simplicity i Sales value at splitoff is simple ii NRV and constant gross-margin percentage NRV methods can be complex for processing operations having multiple products and multiple splitoff points Do multiple choice and Use other methods when selling prices of all products at splitoff point not available a NRV method attempts to approximate sales value at splitoff by subtracting separable costs incurred after splitoff point on each product from selling prices—assuming markup or profit margin attributable to joint process and not to separable costs b Constant gross-margin percentage NRV method assumes all products have the same ratio of cost to sales value (very uncommon in companies that produce multiple products that have no joint costs) c Physical-measure method may be used in rate regulation [Surveys of Company Practice] Purpose of joint-cost allocation important in choosing allocation method H Situations in which joint costs not allocated Inventories carried at NRV recognizing income when production completed Inventories carried at net realizable value minus estimated operating income margin II Irrelevance of joint costs for decision making Learning Objective 6: Explain why joint costs are irrelevant in a sell-or-process-further decision A Decision to sell at splitoff or process further Joint-cost allocations somewhat arbitrary—no cause-and-effect relationship that identifies resources demanded by each joint product that can be used as basis for pricing 220 Chapter 16 Key concept of relevance—joint costs incurred up to the splitoff point whether product sold at splitoff point or processed further [Chapter 11] Do not assume all separable costs in joint-cost allocation always incremental costs Do multiple choice Assign Exercises 16-19, 21, 22, and 23 and Problems 16-28 and 29 B Performance evaluation Potential conflict between cost concepts used for decision making and cost concepts used for evaluating performance of managers Conflict less severe if used market-based methods of joint-cost allocation III Accounting for byproducts Learning Objective 7: Account for byproducts using two different methods A Presence of byproducts can affect allocation of joint costs although byproducts have much lower sales value than joint or main products B Two methods of accounting for byproducts [Exhibits 16-10 and 16-11] Method A: production method—byproducts recognized at time production is completed a Byproduct recognized in financial statement when produced b Estimated NRV of byproduct produced offset against costs of main or joint products c Byproduct inventories at their selling price (variant of using estimated NRV reduced by normal profit margin) Method B: sale method—byproducts recognized at time of sale [Concepts in Action] a Byproducts recognized in financial statement when sold—grouped with other sales (other income) or deducted from cost of goods sold b Byproduct dollar amounts immaterial yet may permit earnings to be “managed” through timing of sales Do multiple choice and 10 Assign Exercises 16-17, 24, and 25 and Problems 16-31, 32, and 33 CHAPTER QUIZ SOLUTIONS: 1.b 2.d 3.c 4.a 5.c 6.b 7.d 8.c 9.b 10.d Cost Allocation: Joint Products and Byproducts 221 CHAPTER QUIZ The following data apply to questions 1–5 Brant Corporation manufactures two products out of a joint process—Scout and Andro The joint (common) costs incurred are $400,000 for a standard production run that generates 70,000 pounds of Scout and 30,000 pounds of Andro Scout sells for $9.00 per pound while Andro sells for $7.00 per pound [CMA Adapted] If there are no additional processing costs incurred after the splitoff point, the amount of joint cost of each production run allocated to Scout on a physical-quantity basis is a $300,000 b $280,000 c $120,000 d $100,000 [CMA Adapted] If there are no additional processing costs incurred after the splitoff point, the amount of joint cost of each production run allocated to Andro on a sales value at splitoff basis is a $300,000 b $225,000 c $175,000 d $100,000 [CMA Adapted] If additional processing costs beyond the splitoff point are $1.00 per pound for Scout and $2.33 per pound for Andro, the amount of joint cost of each production run allocated to Andro on a physical quantity basis is a $300,000 b $280,000 c $120,000 d $100,000 [CMA Adapted] If additional processing costs beyond the splitoff point are $1.00 per pound for Scout and $2.33 per pound for Andro, the amount of joint cost of each production run allocated to Andro on an estimated net realizable value basis is a $80,000 b $147,350 c $175,000 d $320,000 Assume the same cost information as in question The amount of joint cost of each production run allocated to Scout using the constant gross-margin percentage NRV method is a $224,910 b $260,120 c $335,090 d $405,090 [CPA Adapted] For purposes of allocating joint costs to joint products, the sales value at splitoff method could be used in which of the following situations? a b c d No costs beyond splitoff Yes Yes No No 222 Chapter 16 Cost beyond splitoff No Yes Yes No Products G and H are joint products developed from the same process with each being processed further Joint costs are incurred until splitoff, the separable costs are incurred in further refining each product Sales values of G and H at splitoff are used to allocate joint costs If the sales value of G at splitoff increases and all other costs and selling prices remain unchanged, the gross margin of a b c d G increases increases decreases decreases H increases decreases decreases increases [CPA Adapted] Tanner Company manufactures products Katran and Klare from a joint process Product Katran has been allocated $7,500 of total joint costs of $30,000 for the 1,500 units produced Katran can be sold at the splitoff point for $4 per unit, or it can be processed further with additional costs of $2,000 and sold for $7 per unit If Katran is processed further and sold, the result would be a b c d a break-even situation an overall loss of $1,500 a gain of $2,500 from further processing a gain of $1,000 from further processing [CPA Adapted] In accounting for byproducts, the value of the byproduct may be recognized at the time of a b c d Production Yes Yes No No Sale No Yes No Yes 10 [CPA Adapted] Mohler Corporation manufactures a product that yields the byproduct, Jep The only costs associated with Jep are selling costs of $0.10 for each unit sold Mohler accounts for sales of Jep by deducting Jep’s separable costs from Jep’s sales and then deducting this net amount from the major product’s cost of goods sold Jep’s sales were 200,000 units at $1.00 each If Mohler changes its method of accounting for Jep’s sales of showing the net amount as additional sales revenue, the Mohler’s gross margin would a b c d increase by $180,000 increase by $200,000 increase by $220,000 be unaffected Cost Allocation: Joint Products and Byproducts 223 WRITING/DISCUSSION EXERCISES Identify the splitoff point in a joint-cost situation Discuss the interesting situation of having products that come from a common production process begin the cost assignment process with the allocation of indirect costs rather than a cost assignment process that begins with direct costs and then adds the indirect costs Costing systems studied prior to this chapter began the cost assignment process with direct costs of material and manufacturing labor Manufacturing overhead was then added through the allocation process to those traced costs With joint costs, the costing process begins with the allocation of costs Distinguish joint products from byproducts Why is the distinction between joint products and byproducts considered changeable? The designations of joint or main product versus those of byproduct are relative to the product’s sales value The definition of positive sales value for designation as a joint product is not what changes The sales value is subject to change Managers can take an active role in bringing about such changes Output from a joint process can be converted into product by research specifically meant to make it happen, by marketing opportunities, or by being alert to changes in technology, the marketplace, or customers’ questions and requests The opposite can occur—a product can diminish in sales value to the point it becomes a byproduct or must be combined with other products to keep from becoming simply output Explain why joint costs should be allocated to individual products Can some companies choose to avoid allocating joint costs? The section in the chapter, “Avoiding Joint Cost Allocation,” refers to inventory values of individual products and the accounting for end-of-period inventories Inventory costing is among the reasons given for the need to allocate joint costs among individual products If a company can properly account for their inventory of products without allocating the joint costs of those products, the company may so Other reasons are noted as to why joint costs are allocated At some point, a situation would probably occur that would necessitate the allocation of a joint cost Allocate joint costs using four different methods Does it make a difference which method of joint cost allocation is used? In looking at the differences in individual product per unit cost and profitability [Exercise 16-16 and Exhibits 16-4, 5, 7, 9], one can see that the method chosen for allocation does make a difference The more important question is “For what purpose is the cost being allocated?” In Exercise 16-16, the purpose was cost reimbursement and the difference was in the amount that the insurance company would pay for the loss For purposes of deciding whether to sell at splitoff or process further, the allocation amounts are irrelevant and not make a difference In any situation in which the individual product cost is used, the allocation method would make a difference 224 Chapter 16 Explain why the sales value at splitoff method is preferred when allocating joint costs Why does the benefits-received criterion work so well for the sales value at splitoff method of allocating joint costs? The criterion for guiding cost-allocation decisions is selected according to the purpose of the allocation The purpose of allocating joint costs is to cost a product— something that has positive sales value The purpose of the product is to generate revenue or benefit to the company through its sales value Explain why joint costs are irrelevant in a sell-or-process-further decision If a manager had only one income statement to use to make the decision to drop a product, would that manager make the same decision about which product to drop, all other factors kept constant and equal, if the information was from Exhibits 16-4, 5, 7, or 9? If the manager only had the information from the income statements in Exhibits 16-4, 5, 7, or to use to make such a crucial decision, s/he would probably not make the same decision from looking at Exhibit 16- as from looking at the income statements shown in Exhibit 16-5 A manager is aided by having knowledge of accounting and the role of cost allocation The accountant has an obligation to convey information to the manager that is relevant to the decision at hand The allocation of the joint cost is irrelevant to such a decision and should not be included Account for byproducts using two different methods Discuss the concept of materiality, especially as it pertains to accounting for byproducts Should a company adopt guidelines for defining materiality for income statement items? Materiality is an important concept but one that is difficult to reduce to specific numbers Materiality is based upon judgment Judgment can be developed through education and the influence of those in top management who determine the tone of the organization Companies (especially those engaged in auditing) can define materiality in terms of percentage of operating income, for example, both as to the individual item and in the aggregate for purpose of established guidelines—but only for the purpose of a general guide Materiality is a concept necessary to the preparation of financial statements and their usefulness for making decisions Statements full of details are not as useful as statements that report only those items and amounts that make a difference An item or amount is deemed immaterial if the reporting or lack of reporting would not affect the decisions of an informed reader of the financial report Cost Allocation: Joint Products and Byproducts 225 SUGGESTED READINGS Balachandran, B and Ramakrishnan, R., “Joint Cost Allocation: A Unified Approach,” The Accounting Review (January 1981) p.85 [12p] Cheatham, C and Green, M., “Teaching Accounting for Byproducts,” Management Accounting (Spring 1988) p.14 [2p] Lowenthal, F., “Multiple Splitoff Points,” Issues in Accounting Education (Fall 1986) p.302 [7p] Stout, D and Wygal, D., “Making Byproducts a Main Product of Discussion: A Challenge to Accounting Educators,” Journal of Accounting Education (1989) p.219 [15p] 226 Chapter 16 [...]... the financial report Cost Allocation: Joint Products and Byproducts 225 SUGGESTED READINGS Balachandran, B and Ramakrishnan, R., Joint Cost Allocation: A Unified Approach,” The Accounting Review (January 1981) p.85 [12p] Cheatham, C and Green, M., “Teaching Accounting for Byproducts,” Management Accounting (Spring 1988) p.14 [2p] Lowenthal, F., “Multiple Splitoff Points,” Issues in Accounting Education... sales value at splitoff method is preferred when allocating joint costs Why does the benefits-received criterion work so well for the sales value at splitoff method of allocating joint costs? The criterion for guiding cost- allocation decisions is selected according to the purpose of the allocation The purpose of allocating joint costs is to cost a product— something that has positive sales value The... Exhibits 16- 4, 5, 7, or 9 to use to make such a crucial decision, s/he would probably not make the same decision from looking at Exhibit 16- 4 as from looking at the income statements shown in Exhibit 16- 5 A manager is aided by having knowledge of accounting and the role of cost allocation The accountant has an obligation to convey information to the manager that is relevant to the decision at hand The allocation. .. convey information to the manager that is relevant to the decision at hand The allocation of the joint cost is irrelevant to such a decision and should not be included 7 Account for byproducts using two different methods Discuss the concept of materiality, especially as it pertains to accounting for byproducts Should a company adopt guidelines for defining materiality for income statement items? Materiality... Lowenthal, F., “Multiple Splitoff Points,” Issues in Accounting Education (Fall 1986) p.302 [7p] Stout, D and Wygal, D., “Making Byproducts a Main Product of Discussion: A Challenge to Accounting Educators,” Journal of Accounting Education (1989) p.219 [15p] 226 Chapter 16 ... the company through its sales value 6 Explain why joint costs are irrelevant in a sell-or-process-further decision If a manager had only one income statement to use to make the decision to drop a product, would that manager make the same decision about which product to drop, all other factors kept constant and equal, if the information was from Exhibits 16- 4, 5, 7, or 9? If the manager only had the information... Materiality is an important concept but one that is difficult to reduce to specific numbers Materiality is based upon judgment Judgment can be developed through education and the influence of those in top management who determine the tone of the organization Companies (especially those engaged in auditing) can define materiality in terms of percentage of operating income, for example, both as to the individual