Weighted Average Method--Allocating Joint Product Cost:

Learning Objectives:

1. Explain the procedure of allocating joint product cost when weighted average method is used.
2. many industries, the previously described methods do not give a satisfactory answer to the joint cost apportionment problem. For this reason, weight factors are often assigned to each unit, based upon size of the unit, difficulty of manufacture, time consumed in making the unit, difference in type of labor employed, amount of materials used etc. Finished production of every kind is multiplied by weight factors to apportion to total joint cost to individual units.
   Using figures from the average unit cost method page, weight factors assigned to the four products might be as follows:
   

   Example:

   Product A 3 Points Product B 12 Points Product C 13.5 Points Product D 15 Points

   The joint production cost allocation would result in these values:
   

   Product	Units      ×	Points   =	Weighted Units	× Cost Per Units*  =	Joint Production Cost
   A	20,000	3	60,000	0.20	$12,000
   B	15,000	12	180,000	0.20	$36,000
   C	10,000	13.5	135,000	0.20	$27,000
   D	15,000	15	225,000	0.20	$45,000
   			-------------		------------
   			600,000		$120,000
   			=======		=======
   *Total joint production cost / Total number of weighted units = $ 120,000 / 600,000 = $0.20 per unit

    

   Joint Product Cost Analysis for Managerial Decisions and Profitability Analysis:

   Learning Objectives:
   
3. What is the importance of joint product cost analysis for management.

The Securities and Exchange Commission requires that annual reports to stock holders include data by lines of business. Likewise, the Federal Trade Commission requires that certain business furnish  cost and profit data for a wide range of specific product categories. The financial Accounting Standards Board requires business enterprise, excluding nonpublic enterprises, to report in their annual external financial statements the revenue, operating each significant industry segment of their operations. "Significant" generally means 10 percent or more of the total of respective amounts. Aggregate depreciation, depletion, amortization expense, and the amount of capital expenditures must also be reported for each segment. Furthermore, the FASB requires information about foreign operations, export sales, and major customers, who need not be identified. Also, methods used for cost allocations to segments must be disclosed. Interim financial statements are exempt from these requirements. The SEC's discloser requirements are consistent with the provisions contained in FASB statements, yet they call for more information than the FASB.
Companies generally resist such requirements. One of their main arguments is that cost allocation today is fraught with great danger of improper interpretation caused by an arbitrary allocated joint cost. Of course, there are acceptable ways of allocating joint product cost. Thus the choice of method makes a difference. The decision determines the degree of profitability of the various individual products.
joint cost allocation methods indicate only too forcefully that the amount of the cost to be apportioned to the numerous products emerging at the point of split-off is difficult to establish for any purpose. Furthermore, the acceptance of an allocation method for the assignment of the joint production cost does not solve the problem. The thought has been advanced that no attempt should be made to determine the cost of individual products up to the split-off point: rather, it seems important to calculate the profit margin in terms of total combined units. Of course, costs incurred after the split-off point will provide management with information needed for decisions relating to the desirability of further processing to maximize profits.
Production of joint products is greatly influenced by both the technological characteristics of the processes and by the markets available for the products. This establishment of a product mix which is in harmony with customer demands appears profitable  but is often physically impossible. It is interesting to note that cost accounting in the meat packing industry serves primarily as a guide to buying, for aggregate sales realization values of the various products that will be obtained from cutting operations are considered in determining the price that a packer is willing to pay for livestock. Sales realization values are also considered when deciding to sell hams or other cuts in a particular stage or to process them further.
A joint cost is often incurred for products that are either interchangeable or not associated with each other at all. Increasing the out put of one will in most joint cost situations unfavorably increase to some extent the out put of the other. These situations fall into the category of the cost-volume-profit relationship and differential cost analysis. Evaluation of many alternative combinations of output can lead to time consuming computations. Often such evaluations are carried out on a computer using sophisticated simulation techniques. Development in operations research procedures have provided techniques helpful in solving such problems (linear programming technique). For profit planning, and perhaps as the only reliable measure of profitability, management should consider a product's contribution margin after separable or individual costs are deducted from sales. This contribution margin allows management to predict the amount that a segment or product line will add to or subtract from company profit. This margin is not the product's net profit figure. It indicates relative profitability in comparison with other products. "Net profit determined by allocating to segments an equitable share of all costs, both separable and joint, associated with the group of segments not a reliable guide to profit planning decisions because these data cannot be used for predicting the outcome of decisions in terms of the change in aggregate net profit." For those reasons, attempts to allocate joint marketing cost to products and customers by time studies of salespersons' activities, as well as attempts to allocate the joint cost, often yield results which are unreliable for appraising segment profitability.

Quantitative or Physical Unit Method--Allocating Joint Product Cost:

Learning Objectives:

1. Explain quantitative or physical unit method of joint cost allocation.
2. Quantitative or physical unit method attempts to distribute the total joint cost on the basis of some unit of measurement, such as pounds, gallons, tons, or board feet. Of course, the unit products must be measurable by the basic measurement unit. If this isn't possible, the joint units must be converted to a denominator common to all units produced, For example, in the manufacture of coke, products such as coke, coal tar, benzol, sulfate of ammonia, and gas are measured in different units. The yield of these recovered units is measured on the basis of the quantity of product extracted per ton of coal.
   

   Example:

   The example shows the use of weight as a quantitative unit method of joint cost allocation:
   

   Products	Yield in Pounds of Recovered Product Per Ton Coal	Distribution of Waste to Recovered Products	Revised weight of Recovered Products	Materials Cost of Each Product Per Ton of Coal
   Coke	1320.00lbs	69.474*	1389.474	$13.895**
   Coal tar	120.00	6.316	126.316	1.265
   Benzol	21.90	1.153	23.053	0.230
   Sulfate of Ammonia	26.00	1.368	27.368	0.275
   Gas	412.10	21.689	433.789	4.335
   Waste (water)	100.00
   	-------------	--------------	--------------	--------------
   Total	2000.00	100.00	2000.000	$20.000
   	=======	========	========	=======
   *[1,320  ÷ (2,000 – 100)] = 69.0474 **(1,389.474 / 2,000  ) × $20 = $13.895

    

   Average Unit Cost Method--Allocating Joint Product Cost:

   Learning Objectives:
   
3. Explain the use of average unit cost method in joint product cost allocation.

verage unit cost method attempts to apportion total joint production cost to the various products on the basis of a predetermined standard or index of production. An average unit cost is obtained by dividing the total number of units produced into the total joint production cost. As long as all units produced are measured in terms of the same unit and do not differ greatly, the method can be used without too much misgiving. When the units produced are not measured in like terms, the method cannot be applied.

Example:

Using the figures at the market value method page, the procedure can be illustrated as follows:

Total joint production cost / Total number of units produced

$120,000 / 60,000

=$2 per unit

Product Units Joint production cost Allocated A 20,000 $40,000 B 15,000 $30,000 C 10,000 $20,000 D 15,000 $30,000 ---------- $120,0000 =======

Companies using this method argue that all products turned out by the same process should receive a proportionate share of the total joint production cost based on the number of units produced.

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.

Market Value Method or Reversal Cost Method:

Learning Objectives:

1. Define and explain market value method.
2. Explain the use of market value method while costing by-products
3. 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. Dollar recognition depends on the stability of the market as to price and stability of by product; however, control over quantities is important. The by product account is charged with this estimated amount and the production (manufacturing) cost of the main product is credited. Any additional costs of materials, labor, or factory overhead incurred after the by-product is separated from the main product are charged to the by product. The marketing and administrative expenses might also be allocated to the by product on some equitable basis. The proceeds from sales of the by product are credited to the by-product account.  The balance in this account can be presented on the income statement in one of the ways outlined for recognition of gross revenue method except that the manufacturing cost applicable to by product inventory should be reported in the balance sheet.
   The market value method (reversal cost method) of ascertaining main product and by-product costs may be  illustrated as shown in the example below:
   

   Item	Main Product		By Product
   Materials	$50,000
   Labor	70,000
   Factory Overhead	40,000
   	--------
   Total production cost (40,000 units)	$160,000
   Market value (5,000 units @ $1.80)				$9,000
   Estimated gross profit consisting of:
   (20% of selling price, assumed)			$1,8000
   Marketing and selling expenses 5% of selling price			450
   			------	$2,250
   				-------
   Estimated production cost after split-off:
   Materials			$1,000
   Labor			1,200
   Factory Overhead			300
   			-------	2,500
   				-------
   Estimated value of by product at split-off to be credited to main product	4,250			$4,250
   	-----------
   Net cost of main product	$155,750
   Add back actual production cost after split-off				2,300
   				------------
   Total				$6,550
   				======
   Total number of units	40,000			5,000
   Unit cost	$3.894			$1.31

   This example indicates that an estimated value of the by product at the split-off point results when estimated gross profit and production cost after split-off are subtracted from the by-products ultimate market value. Alternatively, if the by-product has a market value at the split-off point, the by-product account is charged with this market value and the main product's production cost would be credited. It is also possible to use the total market values of the main product and the by-product at the split-off point as a basis for assigning a share of the prior split-off costs to the by product, applying the offsetting credit to the production cost of the main product. In any event, subsequent to split-off cost related to the by-product would be charged to the by product.
   Market value method or reversal cost method is based on the theory that the cost of a by product is related to its sales value. It is a step toward the recognition of a by-product cost prior to its split-off from the main product. It is also the nearest approach to methods employed in joint product costing.