Question

One of your client is a manufacturer and produces multiple products and senior management needs answers to some questions. Their questions are:

(a) What do joint cost and splitoff point mean, and how do joint products differ from byproducts?

(b) Why are joint costs allocated to individual products and what methods can be used to allocate joint costs to individual products?

(c) When is the sales value at splitoff method considered preferable for allocating joint costs to individual products and why?

(d) Are joint cost relevant in a sell or process further decision.

Please respond to their concern.

Answer 1

(a) A joint cost is a cost incurred in a joint process. Joint costs may include direct material, direct labor, and overhead costs incurred during a joint production process. A joint process is a production process in which one input yields multiple outputs. Some costs benefit more than one product or process in the manufacturing process. These costs are called joint costs. Almost all manufacturers incur joint costs at some level in the manufacturing process whereas a split-off point is the location in a production process where jointly manufactured products are henceforth manufactured separately; thus, their costs can be identified individually after the split-off point. Prior to the split-off point, production costs are allocated to joint cost.

Joint products differ from Byproducts as :

Joint products are the products which are produced simultaneously, with the same raw material and process, and requires further processing to become a finished product after they get separated. On the other hand, the by-product is nothing but the subsidiary product which emerges out, in the course of the manufacturing of the main product.

So, the main difference between the joint product and by-product lies in the fact that whether the company produced the product on purposely, or it emerged additionally, as a result of ongoing production.

(b) There can be several reasons why Joint costs are allocated to individual products some of which are:

1. Financial Reporting: Joint costs need to be computed and allocated for inventory and cost of goods sold. Financial accounting is the process of creating financial reports for external users. So for proving the stakeholders correct financial information, it is important to allocate the joint cost to individual products.

2. Product pricing: Joint costs are used to compute total product costs. Product costs are then used to determine a profit and a sale price. We need to calculate joint costs to calculate inventoriable costs. Those costs are attached to inventory and expensed when the product is sold. So we need joint costs to calculate inventory values and the cost of goods sold. This information ends up in your financial reports, too.

3. Contracts: Joint costs are part of cost reimbursement under contracts. Under many contracts, we need to justify our costs and document them to receive reimbursement. Essentially, we are proving that your spending met the guidelines in the contract. If we have joint costs, they need to be part of this process.

There can be many other reasons like for settlement of any litigation, for settlement of insurance etc.

Methods to allocate joint production cost

A true joint cost has a characteristic of indivisibility. The methods used to apportion or allocate a joint cost are therefore arbitrary and not perfect. The four acceptable joint cost allocation methods are given below:

1. Market or sales value method

The market or sales value method allocates a joint production cost on the basis of relative market or sales values of individual joint products.

2. Quantitative or physical unit method

This method uses some physical measurement units (such as volume, weight etc.) to allocate joint production cost.

3. Average unit cost method

The average unit cost method, as the name implies, uses average unit cost to allocate the cost before split-off point.

4. Weighted average method

This method assigns predetermined weight factors to joint products based on various factors such as price, production complexity and unit size of the product.

(c) When selling prices for all products exist at splitoff, the sales value at splitoff method is the preferred technique. It is a relatively simple technique that depends on a common basis for cost allocation—revenues. It is better than the physical method because it considers the relative market values of the products generated by the joint cost when seeking to allocate it (which is a surrogate for the benefits received by each product from the joint cost). Further, the sales value at split off method has advantages over the NRV method and the constant gross margin percentage method because it does not penalize managers by charging more for developing profitable products using the output at split-off, and it requires no assumptions about future processing activities and selling prices.

(d) In cost accounting, a sell or further process decision asks whether to sell a product “as is” at the split-off point or to process further.

Joint costs are irrelevant for your “sell or process further” decision. Those costs are the same, whether you sell the product at split-off or process further. In this case, joint costs are sunk or past costs. In other words, they’ve already been paid. So they are not going to affect the decision regarding the sell of product as it is or to produce further.