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Course: Cost and Management Accounting II

Chapter 1: Cost Allocation: Joint Products and Byproducts
Learning Objectives
1) Identify the split off point in a joint cost situation and distinguish joint products from
byproducts
2) Explain why joint costs are allocated to individual products
3) Allocate joint costs using four Methods
4) Explain when the sales value at Split off method is preferred when allocating joint costs
5) Explain why joint costs are irrelevant in a sell-or-process-further decision
6) Account for byproducts using two methods

1) Joint-Cost Basics
 Joint costs are the costs of a production process that yields multiple products
simultaneously.
 The split off point is the juncture in a joint production process when two or more
products become separately identifiable.
 Separable costs are all costs—manufacturing, marketing, distribution, and so on—
incurred beyond the split off point that are assignable to each of the specific products
identified at the split off point
 At or beyond the split off point, decisions relating to the sale or further processing of
each identifiable product can be made independently of decisions about the other
products.
 The term product describes any output that has a positive total sales value
 When a joint production process yields one product with a high total sales value,
compared with total sales values of other products of the process, that product is called a
main product.
 When a joint production process yields two or more products with high total sales values
compared with the total sales values of other products, if any, those products are called
joint products.
 The products of a joint production process that have low total sales values compared with
the total sales value of the main product or of joint products are called byproducts.
 Distinctions among main products, joint products, and byproducts are not so definite in
practice.

2) Allocating Joint Costs

There are several contexts in which joint costs are required to be allocated to individual products
or services. These include the following
1) Computation of inventoriable costs and cost of goods sold.
2) Computation of inventoriable costs and cost of goods sold for internal reporting purposes
3) Rate or price regulation for one or more of the jointly produced products or services
4) Insurance-settlement computations for damage claims made on the basis of cost
information of jointly produced products.

Lecturer: Qasim O Jama (last update February 20, 2024)

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3) Approaches to Allocating Joint Costs

Two approaches are used to allocate joint costs.
Approach 1. Allocate joint costs using market-based data such as revenues. This chapter
illustrates three methods that use this approach:
1) Sales value at split off method: The sales value at split off method allocates joint costs to
joint products produced during the accounting period on the basis of the relative total
sales value at the split off point.
2) Net realizable value (NRV) method: The net realizable value (NRV) method allocates
joint costs to joint products produced during the accounting period on the basis of their
relative NRV—final sales value minus separable costs. The NRV method is typically
used in preference to the sales value at split off method only when selling prices for one
or more products at split off do not exist
3) Constant gross-margin percentage NRV method: The constant gross-margin
percentage NRV method allocates joint costs to joint products produced during the
accounting period in such a way that each individual product achieves an identical gross-
margin percentage. The method works backward in that the overall gross margin is
computed first. Then, for each product, this gross-margin percentage and any separable
costs are deducted from the final sales value of production in order to back into the joint
cost allocation for that product.
Approach 2. Allocate joint costs using physical measures, such as the weight, quantity (physical
units), or volume of the joint products.
The physical-measure method allocates joint costs to joint products produced during the
accounting period on the basis of a comparable physical measure, such as the relative weight,
quantity, or volume at the split off point.
Use the following symbols to distinguish a joint or main product from a byproduct:

Example 1: the joint products are sold at the split off point without further processing.

Lecturer: Qasim O Jama (last update February 20, 2024)

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Farmers’ Dairy purchases raw milk from individual farms and processes it until the split off
point, when two products—cream and liquid skim—emerge. These two products are sold to an
independent company, which markets and distributes them to supermarkets and other retail
outlets. In May 2012, Farmers’ Dairy processes 110,000 gallons of raw milk. During processing,
10,000 gallons are lost due to evaporation and spillage, yielding 25,000 gallons of cream and
75,000 gallons of liquid skim. Summary data follow

Required
Under the sales value at split off method
a) Calculate the weight that joints cost can be allocated to the main products
b) Calculate joint production cost per gallon of cream and liquid skim
c) How much of the joint costs of $400,000 should be allocated to the cost of goods sold of
20,000 gallons of cream and 30,000 gallons of liquid skim and how much should be
allocated to the ending inventory of 5,000 gallons of cream and 45,000 gallons of liquid
skim.
d) Prepare production line income statement
e) Calculate gross profit margin percentage for each product
f) Why the gross profit margin percentage is same for the two products

Under the Physical measure method

Lecturer: Qasim O Jama (last update February 20, 2024)

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g) Calculate the weight that joints cost can be allocated to the main products
h) Calculate joint production cost per gallon of cream and liquid skim
i) How much of the joint costs of $400,000 should be allocated to the cost of goods sold of
20,000 gallons of cream and 30,000 gallons of liquid skim and how much should be
allocated to the ending inventory of 5,000 gallons of cream and 45,000 gallons of liquid
skim.
j) Prepare production line income statement
k) Calculate gross profit margin percentage for each product
l) Why the gross profit margin percentage of the cream is better that then liquid skim

Net Realizable Value Method

Lecturer: Qasim O Jama (last update February 20, 2024)

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In many cases, products are processed beyond the split off point to bring them to a marketable
form or to increase their value above their selling price at the split off point. For example, when
crude oil is refined, the gasoline, kerosene, benzene, and naphtha must be processed further
before they can be sold. To illustrate, let’s extend the Farmers’ Dairy example.

Example 2: Assume the same data as in Example 1 except that both cream and liquid skim
can be processed further:
Cream ➞Butter cream: 25,000 gallons of cream are further processed to yield 20,000 gallons of
butter cream at additional processing costs of $280,000. Butter cream, which sells for $25 per
gallon, is used in the manufacture of butter-based products.
Liquid Skim ➞Condensed Milk: 75,000 gallons of liquid skim are further processed to yield
50,000 gallons of condensed milk at additional processing costs of $520,000. Condensed milk
sells for $22 per gallon.
Sales during May 2012 are 12,000 gallons of butter cream and 45,000 gallons of condensed milk.

Required

Lecturer: Qasim O Jama (last update February 20, 2024)

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By using Net Realizable Value

a) Final sales value of total production during accounting period
b) Calculate the net realizable value at split off point of further process product
c) Calculate the weighting that the joint costs can be allocated for each product
d) Calculate production cost per gallon for each product
e) Prepare production line income statement

Constant Gross-Margin Percentage NRV Method

The constant gross-margin percentage NRV method allocates joint costs to joint products
produced during the accounting period in such a way that each individual product achieves an
identical gross-margin percentage. The method works backward in that the overall gross margin
is computed first. Then, for each product, this gross-margin percentage and any separable costs
are deducted from the final sales value of production in order to back into the joint cost
allocation for that product.
The method can be broken down into three discrete steps.
1. Compute overall gross margin percentage
2. Compute total production costs for each product
3. Compute allocated joint costs.

Example 3: Joint Costs Using Constant Gross-Margin Percentage NRV Method

By using information in example 2
a) Calculate joint costs allocated to each product under CGMP NRV method
b) Prepare a production income statement

Sell-or-Process-Further Decisions

Consider Farmers’ Dairy’s decision to either sell the joint products, cream and liquid skim, at the
split off point or to further process them into butter cream and condensed milk. The decision to
incur additional costs for further processing should be based on the incremental operating income
attainable beyond the split off point.
Example 3: Sell-or-Process-Further Decision

Required

By referring example 2 above is it better to further process the cream and liquid skim or to sell
them at the split off point.

Lecturer: Qasim O Jama (last update February 20, 2024)

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Accounting for Byproducts

Joint production processes may yield not only joint products and main products but also
byproducts. Although byproducts have relatively low total sales values, the presence of
byproducts in a joint production process can affect the allocation of joint costs.
Production Method: Byproducts Recognized at Time Production Is Completed.
Sales Method: Byproducts Recognized at Time of Sale
This method makes no journal entries for byproducts until they are sold. Revenues of the
byproduct are reported as a revenue item in the income statement at the time of sale.
These revenues are either grouped with other sales, included as other income, or are deducted
from cost of goods sold

Example 4: Accounting for Byproducts

The Westlake Corporation processes timber into fine-grade lumber and wood chips that are used
as mulch in gardens and lawns. Information about these products follows:
 Fine-Grade lumber (the main product)—sells for $6 per board foot (b.f.)
 Wood chips (the byproduct)—sells for $1 per cubic foot
(c.f.) Data for July 2012 are as follows:

Required
a) Prepare income statement under both production method and sales method
b) Prepare the journal entries for each method

Lecturer: Qasim O Jama (last update February 20, 2024)