Characteristics of Joint Products and Joint Cost:

Many products or services are linked together by physical relationships which necessitate simultaneous production. To the point of split-off or to the point where these several products emerge as individual units, the cost of the products forms a homogeneous whole.
The classic example of joint products is found in the meat packing industry, where various cuts of meet and numerous by products are processed from one original carcass with one lump-sum cost. An other example of joint products manufacturing is the production of gasoline, where the derivation of gasoline inevitably results in the production of such items as naphtha, kerosene, and distillate fuel oils. Other examples of joint products manufacturing are the simultaneous production of various grads of glue and the processing of soybeans into oil and meal. Joint product costing is also found in industries that must grade raw materials before it is processed. Tobacco manufacturers (except in cases where graded tobacco is purchased) and virtually all fruit and vegetables canners face the problem of grading. In fact, such manufacturers have a dual problem of joint cost allocation:

1. Materials cost is applicable to all grades
2. Subsequent manufacturing costs are incurred simultaneously for all the different grads.

The chief characteristic of the joint cost is the fact that the cost of these several different products is incurred in an indivisible sum for all products, rather than in individual amounts for each product. The total production cost of multiple products involves both joint cost and separate, individual products cost. These separable product costs are identifiably with the individual product and, generally, need no allocation. However, the joint production cost requires allocation or assignment to the individual products.

Market or Sales Value Method--Allocation of Joint Cost:

Learning Objectives:

1. Explain the market value method or sales value method of joint cost allocation between products.

Market or sales value method enjoys great popularity  because of the argument that market value of any product is a manifestation of the cost incurred in its production. The contention is that if one product sells for more than another, it is because more cost was expended to produce it. Therefore, the way to prorate the joint cost is on the basis of the respective market values of the items produced. The method is really a weighted market value basis using the total market or sales value of each unit (quantity sold times the unit sales price).

Example:

Joint products A, B, C and D are produced at a total joint production cost of $120,000. Quantities produced are: A, 20,000 units; B, 15,000 units; C, 10,000 units; and D, 15,000 units. Product A sells for $0.25; B, for $3; C, for $3.5; and D, for $5. These prices are market or sales values for the products at the split-off point; i.e., it is assumed that they can be sold at a that point. Management may have decided, however, that it is more profitable to process certain products further before they are sold. Nevertheless, this condition does not destroy the usefulness of the sales value at the split-off point for the allocation of the joint production cost. The proration of this joint cost is made in the following manner:

Joint Products No. of Units Produced Market Value per Unit Total Market Value Ratio of Product Value to Total Market Value Apportionment of the Joint Production Cost A 20,000 $0.25 $5,000 3.125% $3,750 B 15,000 $3.00 $45,000 28.125% 33,750 C 10,000 $3.50 $35,000 21.875% 26,250 D 15,000 $5.00 $75,000 46.875% 56,250   ----------   --------- ---------- --------- Total 60,000   $160,000 100.00% $120,000   =====   ======= ======= =======

The same results can be obtained if the total joint production cost ($120,000) is divided by the total market value of the four products ($160,000). The resulting 75 percent is the percentage of joint cost in each individual market value. By multiplying each market value by this percentage, the joint production cost will be apportioned as shown in the percentage chart.
Proponents of the market value method or sales value method stat that the joint cost should be assigned to products in accordance with their sales value because, were it not for such a cost, a sales value would not exist. Under this method, each Joint product yields the same unit gross profit percentage, assuming that the units are sold without further processing. This can is illustrated in the following example:

Total A B C D Sales--Units 52,000 18,000 12,000 8,000 14,000 Ending inventory 8,000 2,000 3,000 2,000 1,000 Sales--Dollars $138,5000 $4,500 $36,000 $28,000 $70,000   ----------- ----------- ----------- ----------- ----------- Production Cost $120,000 $3,750 $33,750 $26,250 $56,250 Less Ending inventory 16,125 375* 6,750 5,250 3,750   ----------- ----------- ---------- ---------- ---------- Cost of Goods Sold $103,875 $3,375 $27,000 $21,000 $52,5000             Gross Profit $34,625 $1,125 $9,000 $7,000 $17,500   ====== ====== ====== ====== ====== Gross Profit Percentage 25% 25% 25% 25% 25% *$3,750 production cost ÷ 20,000 units produced = $0.1875; $0.1875 × 2000 units in ending inventory = $375

Consideration of Cost After Split-Off Point:

Products not stable in their stage of completion at the split-off point and therefore without any market value require additional processing to place them in marketable condition. In such cases, the basis for allocation of the joint production cost is a hypothetical market value at the split-off point. To illustrate the procedure, the assumptions listed below are added to the preceding example:

Product Ultimate Market Value per Unit Processing Cost After Split-Off A $0.50 $2,000 B $5.00 $10,000 C $4.50 $10,000 D $8.00 $28,000

To arrive at the basis of the apportionment, it is necessary to use a working back procedure whereby the after split-off processing cost is subtracted from the ultimate sales value to find a hypothetical market value. The following illustration indicates the steps to be taken.

Product Ultimate Market Value Per Unit Units Produced Ultimate Market Value Processing Cost After Split-Off Hypothetical Market Value* Apportionment of Joint Production Cost** Total Production Cost Total Production Cost Percentage*** A $0.50 20,000 $10,000 $2,000 $8,000 $4,800 $6,800 68.00 B $5.00 15,000 $75,000 $10,000 $65,000 $39,000 $49,000 65.30 C $4.50 10,000 $45,000 $10,000 $35,000 $21,000 $31,00 68.80 D $8.00 15,000 $120,000 $28,000 $92,000 $55,200 $83,200 69.30   ---------- ---------- ----------- ----------- ------------ ------------ ----------- --------- Total     $250,000 $50,000 $200,000 $120,000 $170,000 68.00       ====== ====== ====== ======= ====== ======   *At the split-off point   **Percentage to allocate joint production cost (using the joint cost total determined)   Joint production cost / Hypothetical market value = $120,000 / $200,000 = 0.60 = 60%   60%  Hypothetical market value = Apportionment of joint production cost   ***The production cost percentage is calculated by dividing total production cost by the ultimate market value; e.g., $49,000 / $75,000 = 0.653 = 65% for product B, and $170,000 / $250,000 = 0.68 = 68% for all products combined

The following illustration uses the same number of units sold as was used in the preceding illustration.

Total A B C D Sales-Units 52,000 18,000 12,000 8,000 14,000 Sales-Dollars $217,000 $9,000 $60,000 $36,000 $112,000   ---------- --------- --------- --------- --------- Cost of Goods Sold:           Joint production cost $120,000 $4,8000 $39,000 $21,000 $55,200 Further processing cost $50,000 $2,000 $10,000 $10,000 $28,000   ---------- ---------- ---------- ---------- ---------- Total $170,000 $6,800 $49,000 $31,000 $83,200 Less Ending inventory 22,211 680* 9795 6,192 5,544   ----------- ---------- ---------- ----------- ---------- Cost of goods sold $147,789 $5,120 $39,205 $24,808 $77,656   ----------- ----------- ---------- ---------- ---------- Gross profit $69,211 $2,880 $20,795 $11,192 $34,344   ======= ====== ====== ======= ====== Gross profit percentage 32% 32% 35% 31% 31% *6,800 production cost / 20,000 units produced = $0.34; $0.34  2,000 units in ending inventory = $600

Since the statement has often been made that every Joint product should be equally profitable, the following modification of the sales value technique has been suggested. The overall gross profit percentage (32%) is used to determine the gross profit for each product. The gross profit is deducted from sales value to find the total cost, which is reduced by each product's further processing cost to find the joint cost allocation for each product.

Total A B C D Ultimate sales value $250,000 $10,000 $75,000 $45,000 $120,000 Less 32% gross profit 80,000 3,200 24,000 14,400 38,400   ----------- ----------- ------------ ----------- ---------- Total cost $17,000 $6,800 $51,000 $30,600 $81,600 Further processing cost 50,000 2,000 10,000 10,000 28,000   ----------- ------------ ----------- ----------- ---------- Joint cost $120,000 $4,800 $41,000 $20,600 $53,600

If sales value, gross profit percentage, or further processing costs are estimated, the balance labeled "joint cost" would serve as the basis for allocating the actual cost to the four products.