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Cost Allocation: Joint Products and By-products Cost Allocation: Joint Products and By-products

Cost Allocation: Joint Products and By-products - PowerPoint Presentation

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Cost Allocation: Joint Products and By-products - PPT Presentation

ACCT7320 Dr Bailey Nature of Cost Allocations Pervasive in accounting Across time depreciation Between departments eg service depts To products customers branch offices etc Often arbitrary ID: 162944

products joint product 000 joint products 000 product costs splitoff sales cost 500 point method production process sold units

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Slide1

Cost Allocation: Joint Products and By-products

ACCT7320Dr. BaileySlide2

Nature of Cost Allocations

Pervasive in accountingAcross time (depreciation)Between departments (e.g., service depts

)To products, customers, branch offices, etc.Often arbitraryMay mislead in decision makingSlide3

Criteria to GuideCost-Allocation Decisions

Cause-and-effect:

Using this criterion, managers identify the

variable or variables that cause resources

to be consumed.

Benefits-received:

Using this criterion, managers identify the

beneficiaries of the outputs of the cost object.Slide4

Criteria to GuideCost-Allocation Decisions

Fairness or equity:

This criterion is often cited on government

contracts when cost allocations are the basis

for establishing a price satisfactory to the

government and its suppliers.

Ability to bear:

This criterion advocates allocating costs in proportion

to the cost object’s ability to bear them.Slide5

Role of Dominant Criteria

The cause-and-effect

and the benefits-

received criteria

guide most

decisions related

to cost allocations.

Fairness and ability

to bear are less

frequently used.

Why?Slide6

Role of Dominant Criteria

Fairness is an especially difficult criterion

to obtain agreement on.

The ability to bear criterion raises issues

related to cross-subsidization across users

of resources in an organization.Slide7

Joint Costs

This “joint cost” problem arises when companies inescapably produce two or more products simultaneously out of the same process.How do they allocate costs to jointly-produced products.How are the resulting allocations useful?Slide8

Joint-Cost Basics

Joint costs are the costs of a single production process that yields multiple products simultaneously.Industries abound in which a single production process simultaneously yields two or more products.Slide9

Joint-Cost Basics

Tomatoes

Tomato juice

Tomato sauce

Tomato pasteSlide10

Joint-Cost Basics

Coal

Gas

Benzol

TarSlide11

Joint-Cost Basics

The outputs of a joint production process fall into two general categories:Joint products—those that the company is in business to produce (higher total value)By-products—those that also emerge (lesser value)Slide12

Splitoff Point

The splitoff point is the juncture in the production process where one or more products in a joint-cost setting become separately identifiable.

Separable costs are all costs (manufacturing, marketing, distribution, etc.) incurred beyond the splitoff point that are assignable to one or more individual products.Slide13

Joint Products and By-products

Joint products have relatively high sales value at the splitoff point.Main product

is the result of a joint production process that yields only one product with a relatively high sales value.By-products are incidental products resulting from the processing of another product.Slide14

Joint Products and By-products

A by-product has a relatively low sales value compared with a joint or main product.Revenue from byproducts generally reduces the costs of the joint products. We aren’t studying the details.

Some outputs of the joint production process have zero sales value.“Waste” can be ignored in accountingSlide15

Joint Products and By-products

Sales Value

High

Low

Main or

Joint Products

By-productsSlide16

Joint Products and By-products

To reiterate: sales value determines the classificationProducts can change from by-products to joint products when their relative sales values increases, and vive-versa

Kerosene once main product of petroleumSlide17

Why Allocate Joint Product Costs?

The purposes for allocating joint costs to products include:Inventory costing Important for financial accounting purposes, reports to income tax authorities, and internal reporting purposes.

Cost reimbursement contractsCost allocation is required for cost reimbursement purposes under contracts when only a portion of a business’ products or services is sold or delivered to a single customer (government agency).Slide18

Why Allocate Joint Product Costs?

Insurance settlementsRequire cost allocation when damage/loss claims made by manufacturer: What was the “cost”?

Rate regulationIf one or more of the jointly produced products or services are subject to price regulation (nat. gas).LitigationJoint cost allocation is important in litigation involving one or more joint products.Slide19

How to Allocate Joint Costs?

The two basic approaches to allocating joint costs are:Use market-based data such as relative product revenues.“Sales value at splitoff”

“Estimated net realizable value”Use physical measures such as weight or volume.Slide20

Allocating Joint Costs

Lubbock Company incurred $200,000 of joint costs to produce the following:Product A: 10,000 units, 20,000 pounds Product B: 10,500 units, 48,000 pounds

Product C: 11,500 units, 12,000 poundsSlide21

Sales Value at Splitoff Method

Allocates joint costs to joint products on the basis of the relative total sales value at the splitoff point.All outputs must have sales values at this point to use the method.Slide22

Sales Value at Splitoff Method

Assume the following sales values per unit: A: $10.00, B: $30.00, and C: $20.00What is the

total sales value at splitoff point?Product A: 10,000 × $10.00 = $100,000 15.5%Product B: 10,500 × $30.00 = 315,000 48.8%Product C: 11,500 × $20.00 = 230,000

35.7%

Total $645,000 100%Slide23

Sales Value at Splitoff Method

How much joint costs are allocated to each product?A: 15.5%× $200,000 = $ 31,008 B: 48.8% × $200,000 = 97,674

C: 35.7% × $200,000 = 71,318 Total $200,000Slide24

Sales Value at Splitoff Method

What are the joint production costs per unit?Product A: $31,008 ÷ 10,000 = $3.10Product B: $97,674 ÷ 10,500 = $9.30

Product C: $71,318 ÷ 11,500 = $6.20Slide25

Sales Value at Splitoff Method

Assume all of the units produced of B and C were sold (no further processing). 2,500 units of A (25%) remain in inventory.What is the gross margin percentage of each product?Slide26

Sales Value at Splitoff Method

Product A Revenues: 7,500 units × $10.00 $75,000

Cost of goods sold: Joint product costs $31,008 Less ending inventory 7,752* 23,256*$31,008 × 25%

Gross margin $51,744Slide27

Sales Value at Splitoff Method

Prod. A: $75,000 – $ 23,256 = $51,744; $51,744 ÷ $75,000 = 69%Prod. B: ($315,000 – $97,674) ÷ $315,000 = 69%Prod. C: ($230,000 – $71,318) ÷ $230,000 = 69%

The

sales value at splitoff method

produces an identical gross margin percentage for each product.Slide28

Estimated Net Realizable Value (NRV) Method

Often products are processed further beyond the splitoff point to make them marketable or increase their value.Slide29

Estimated Net Realizable Value (NRV) Method

The estimated NRV method allocates joint costs to joint products on the basis of the relative estimated

NRV.NRV = (expected final sales value in the ordinary course of business) – (expected separable costs of the total production of these products)Slide30

Absolute Irrelevance of Joint Costs for Decision Making

Joint costs incurred up to the splitoff point are past (sunk) costs irrelevant to the decision to sell a joint (or main) product at the splitoff point or to process it further.Slide31

Irrelevance of Joint Costs for Decision Making

Assume that products A, B, and C can be sold at the splitoff point (at price1

) or processed further into A1, B1, and C1 and sold at price2.

Units

price1

price2 Add’l costs

10,000 A: $10

A1

: $12 $35,000

10,500 B: $30

B1

: $33 $46,500

11,500 C: $20 C1: $21 $51,500Slide32

Irrelevance of Joint Costs for Decision Making

Should A, B, or C be sold at the splitoff point or processed further?

Product A: Incremental revenue $20,000 – Incremental cost $35,000 = ($15,000)Product B: Incremental revenue $31,500 – Incremental cost $46,500 = ($15,000)Product C: Incremental revenue $11,500 – Incremental cost $51,500 = ($40,000)Slide33

Irrelevance of Joint Costs for Decision Making

Products A, B, and C should be sold at the splitoff point.No techniques for allocating joint-product costs can guide decisions about whether a product should be sold at the splitoff point or processed beyond splitoff.Slide34

The End