Joint and by Products | Revenue | Prices

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  Chapter 13-2 Notes Page 1 Please Send Comments and Corrections to me at mconstas@csulb.edu  Joint Products Accounting For Joint Product Costs Joint Products and By-Products are produced from one production process (Joint Process). There are no separate products until after the Joint Process is completed. For example, on a dairy farm, the raw milk is processed into a number of Joint Products: milk, cheese, cream, butter and other dairy products. Similarly, in a slaughter house operation, one cow produces a number of Joint Products: leather and various cuts of beef. Additionally, in a petroleum refining process, crude oil is processed into such Joint Products as gasoline, kerosene, heating oil, and lubricating oil. The point at which you can identify the Joint Products as separate products is referred to as the Split-Off Point (e.g., after churning the milk). Joint Products are the main products produced from the Joint Process (determined by value and/or quantity). By-Products, on the other hand, are outputs from the Joint Process that are relatively minor in quantity and/or value. For example, the parts of the cow that humans do not ordinarily eat are considered By-Products (e.g., dog food and animal feed). They have a value, but we did not raise the cow in order to get these parts (e.g., the heart and brains). The differentiation between Joint Products and By-Products is a subjective determination, and there is no objective test to distinguish between Joint Products and By-Products. Also, the characterization of a product as a By-Product or Joint Product can change as circumstances change. For example, sawdust and wood chips used to be characterized as By-Products. Now, with the increased popularity of particle board, they are characterized as Joint Products. The production costs up to the Split-Off Point are called Joint Costs. For example, the cost of raising and milking a cow is a Joint Cost in a diary operation. Because there were no separate products at the time that the Joint Costs were incurred, it is not clear which Joint Costs should be allocated to which Joint Products. In practice, a number of different methods are used to allocate Joint Costs to the Joint Products. It is preferred to base the allocation of Joint Costs to Joint Products using the relative fair market values of the Joint Products. The rationale for this preference is that we entered into the Joint Process more for the higher value Joint Products than the lower value Joint Products, and the allocation of Joint Costs should reflect this. For example, it is likely that a cow was raised more for its steaks than for its hamburger. We will discuss three  Chapter 13-2 Notes Page 2 Please Send Comments and Corrections to me at mconstas@csulb.edu methods that employ fair market values: (i) Sales Value at Split-Off Method, (ii) Net Realizable Value Method, (iii) Constant Gross Margin Percentage Method. It is sometimes difficult to ascertain the fair market value of Joint Products. For example, you may be in a situation where you need to know the cost of a product before you can know its price. This is true if you are in a regulated industry, and the price of the Joint Product is set by a government agency that bases the approved price of a product on that product’s cost. You have the same problem when the contracted price of a Joint Product is set by a “cost plus profit” formula. The value of the Joint Products is also suspect where the Joint Products are sold to related parties using arbitrary intra-company prices. You also have a problem determining fair market values where the Joint Products are intermediate products that are processed so much before they are finally sold that the final sales price has little relationship with the Joint Products at the Split-Off Point. For this reason, companies also use the Physical Units Method, which does not employ fair market values in allocating Joint Costs. Assume that no Joint Costs are allocated to By-Products. We will discuss how to handle By-Products at the end of this discussion. Physical Units Method The Physical Units Method (also known as Physical Quantities Method or the Physical Measures Method) allocates Joint Costs without regard to fair market values. Under this method, you allocate the Joint Costs to the Joint Products using the relative number of units (or some other physical attribute like BTUs or caloric values) of each Joint Product. Assume that Babs Nut Co. spends $60 to harvest one tree. This harvesting process produces three products: Premium Nuts, Nuts, and Nut Pieces quantities and values:  Chapter 13-2 Notes Page 3 Please Send Comments and Corrections to me at mconstas@csulb.edu If Nut Pieces are treated as a Joint Product (rather than as a By-Product), then the Physical Units Method would allocate the $60 Joint Cost between the three Joint Products as follows: Product Units Produced Relative Units x Joint Costs Share of Joint Costs Cost Per Unit Premium 2 2/15 x $60 = $ 8 $4 Nuts 3 3/15 x $60 = $12 $4 Pieces 10 10/15 x $60 = $40 $4 15 If Nut Pieces are treated as a By-Product, then the Physical Units Method would allocate the $60 Joint Cost only between the two Joint Products (Premium Nuts and Nuts). (Recall that By-Products are not allocated Joint Costs.) Product Units Produced Relative Units x Joint Costs Share of Joint Costs Cost Per Unit Premium 2 2/5 x $60 = $24 $12 Nuts 3 3/5 x $60 = $36 $12 5 As you can see in the foregoing table, the Physical Units Method produces the same unit cost for every Joint Product because each unit of every Joint Product is treated as equal. As noted above, this approach ignores the fact that the motivation to undertake the Joint Process was probably due more to the Joint Products with a higher value than to the Joint Products with a lower value. Thus, higher value Joint Products should probably bear a higher portion of the Joint Cost. Giving all of the units the same cost will make the higher value Joint Products more profitable than they should be, and will make the lower value Joint Products less profitable that they should be. To avoid inaccurate costing, some firms introduce weights in the Physical Units Method in order to counter this effect. Sales Value at Split-Off Method The Sales Value at Split-Off Method allocates the Joint Costs to the Joint Products using the relative sales value immediately after the Split-Off Point. Using the above example, assume that Babs Nut Co. wishes to use the Sales Value at Split-Off Method rather than the Physical Units Method.  Chapter 13-2 Notes Page 4 Please Send Comments and Corrections to me at mconstas@csulb.edu If Nut Pieces are treated as a Joint Product (rather than as a By-Product), then the Sales Value at Split-Off Method would allocate the $60 Joint Cost between the three Joint Products as follows: If Nut Pieces are treated as a By-Product, then the Sales Value at Split-Off Method would allocate the $60 Joint Cost between the two Joint Products as follows: Net Realizable Value Method When a Joint Product is processed further after the Split-Off Point, it may not have a Sales Value at the Split-Off Point. Despite this, you may wish to allocate Joint Costs using a method that employs fair market values. In this case, you can work backwards to approximate a market value by assuming that the value at the Split-Off Point is equal to the final sales value of the Joint Product (or products derived from the Joint Product) reduced by the further processing costs incurred. This is called the Net Realizable Value Method. Assume that Dr. Jekyll Chemical Co. produces three final products from two processes as described below: Units Price at Split-Off Total Value Relative Value X Joint Costs Share of Jt. Costs Cost Per Unit Premium 2 $30 $60   $60/100 x $60 = $36 $18 Nuts 3 $10 $30 $30/100 x $60 = $18 $ 6 Pieces 10 $ 1 $10 $10/100 x $60 = $ 6 60¢ 15 $100 Units Price at Split-Off Total Value Relative Value X Joint Costs Share of Jt. Costs Cost Per Unit Premium 2 $30 $60   $60/90 x $60 = $40 $20 Nuts 3 $10 $30 $30/90 x $60 = $20 $6.67 5 $90
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