Friday, August 6, 2010

By Products and Joint Products Costing:

Learning Objectives:
  1. What are by products and joint products?
  2. What are the methods of costing by products?
  3. How joint cost is allocated between products.
  4. Introduction to By Products and Joint Products:

    Many industrial concerns are confronted with the difficult and often rather complicated problem of assigning costs to their by-products and joint products. Chemical companies, coke manufacturers, refineries, flour mills, coal mines, lumber mills, gas companies, dairies, canners, meat packers, and many others produce in their manufacturing or conversion processes a multitude of products to which some cost must be assigned. Assignment of costs of these various products enhances equitable inventory costing for income determination and financial statement purposes. An even more important aspect of by product and joint product costing is that it furnishes management with data for use in planning maximum profit potentials and evaluating actual profit performance.
    Difficulties in costing by products and joint products:
    By products and joint products are difficult to cost because a true joint cost is indivisible. For example, an ore might contain both lead and Zink. In the raw state, these minerals are joint products, and until they are separated by reduction of the ore, the cost of finding mining, and processing is a joint cost; neither lead nor Zink can be produced without the other prior to the .
    Joint Products and Joint Product Costs:
    Joint products are produced simultaneously by a common process or series of processes, with each product processing more than a nominal value in the form in which it is produced. 
    By Products:
    The term "by product" is generally used to denote one or more products of relatively small total value that are produced simultaneously with a product of greater total value. 

    Methods of Costing By-Products:

    The accepted methods for costing by-products fall into two categories:

    Category 1:

    A joint production cost is not allocated to the by product. Any revenue resulting from sales of the by product is credited either to income or to cost of the main product. In some cases, costs subsequent to split-off point may be offset against the by-product revenue. For inventory costing, any independent value may be assigned to the by product. The methods most commonly used in industry are:
    Method 1: Recognition of Gross Revenue:
    Revenue from sales of the by product is listed on the income statement as:

  5. Other income.
  6. Additional sales revenue.
  7. A deduction from the cost of goods sold of the main product.
  8. A deduction from the total manufacturing cost of the main product. 
Method 2: Recognition of Net Revenue:
Revenue from sales of the by product less the costs of placing the by product on the market (marketing and administrative expenses) and less any additional processing cost of the by-product is shown on the income statement in a manner similar to that indicated in method 1.

Method 3: Replacement cost method:
Replacement cost method ordinarily is applied by firms whose by-products are used within the plant, thereby avoiding the necessity of purchasing materials and supplies from outside suppliers. 

Category 2:

Some portion of the joint production cost is allocated to the by product. Inventory costs are based on this allocated cost plus any subsequent processing cost. In this category, the following method is used:
Method 4: Market value method or reversal cost method:
The market value method or reversal cost method is similar to the last technique (By Product Revenue deducted from Production Cost) illustrated at recognition of gross revenue method page. However it reduces the manufacturing cost of the main product , not by the actual revenue received, but by an estimate of the by products value at the time of recovery. This estimate must be made prior to split-off from the main product. 

Characteristics of Joint Products and Cost:
Many products or services are linked together by physical relationships which necessitate simultaneous production. 

Methods of Allocating the Joint Production Cost:

The allocation of joint product cost incurred up to the split-off point can be made by:
  1. The market or sales value method, based on the relative market values of the individual products.
  2. The quantitative or physical unit method, based on some physical measurement unit such as weight, linear measure, or volume.
  3. The average unit cost method.
  4. The weighted average method, based on a predetermined standard or index of production.
Joint Product Cost Analysis For Managerial Decisions and Profitability Analysis:
Get information about how managerial decisions are affected by joint production costs and methods used to allocate joint costs. 

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