Chapter 8

Joint and
by-
product
costing
Joint and by-product costing
Learning Objectives

 distinguish between joint products and by-products;

 explain and identify the split-off point in a joint cost situation;

 explain the alternative methods of allocating joint costs to

products;

 discuss the arguments for and against each of the methods

of allocating joint costs to products;

 present relevant financial information for a decision as to

whether a product should be sold at a particular stage or
further processed;
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 describe the accounting treatment of by-products.
Introduction

 It is necessary to assign all product-related costs

(including joint costs) to products so that costs can be
allocated to inventories and cost of goods sold.

 This exercise is done to determine internal and external

profitability and inventory valuation requirements.

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Introduction

 Joint and by-products are not identifiable as different

products until a specific point in the production process is
reached.

 A split-off point

 Before the split-off point, joint costs are incurred on the

production of all products emerging from the joint
production process.

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Introduction

 Before the split off point, it is not possible to trace joint

costs to individual products.

 For instance, joint products in the meat packing industry,

where various cuts of meat (e.g., pork chops, bacon and
ham) are joint products that are processed from one
original carcass.

 The cost of obtaining the carcass is a joint cost that must

be allocated to the various cuts of meat.

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Introduction

 Another example, the production of gasoline, where the

derivation of gasoline inevitably results in the production of
various joint products such as gasoline, fuel oil, kerosene
and paraffin.

 Let's look at the diagram

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Gasoline production

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Joint and separable costs
 Joint costs – total of raw material, labour and overhead costs incurred
up to the initial split-off point;

 Joint costs – can be allocated to the final product only in some arbitrary
manner because such costs cannot be traced directly to the products
they benefit;

 Joint cost allocation is much less useful for cost control and managerial
decision-making;

 Separable costs are those costs incurred after the split-off point; they
can be traced to individual products with ease.
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Joint and by-products

 We can distinguish between joint products and by-products

by looking at their relative sales value.

 When a group of individual products is produced

simultaneously and each product has a significant relative
sales value, the outputs are usually called joint products.

 Products that only have a minor sales value when

compared with the joint products are called by-products.

 By-products are those products that result incidentally from

the main joint products.

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Joint and by-products

 The sales value of by-products is small when compared

with the values of the joint products.

 Joint products are crucial to the commercial viability of an

organization, whereas by-products are incidental.

 By-products do not usually influence the decision as to

whether to produce the main product.

 They normally have little effect on the prices set for the
main (joint) products.

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Joint and by-products

 All products may separate at one time, or different

products may emerge at intervals.

 Before the split-off point, costs cannot be traced to a

particular product.

 For instance , it is not possible to determine what part of

the cost of processing a barrel of crude oil should be
allocated to petrol, kerosene or paraffin.

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Joint and by-products

 After the split-off point, joint products may be sold or

subjected to further processing.

 Any further processing costs can be traced to the specific

products involved.

 Figure 8.1 illustrates a simplified production process for

joint and by-products.

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Joint and by-products

 In this example, joint products A and B and by-product C

all emerge at the same split-off point.

 Before this point, they share the same raw materials,

labour and overhead costs. After the split-off point, further
processing costs

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Joint and by-products – Fig. 8.1

14
Methods of allocation of joint costs

 There is more than one method of allocating joint costs to

products

 The choice of method can have significant implications for

the calculation of profit and the valuation of inventories.

 This area will involve the accountant in making subjective

decisions that can be among the most difficult to defend.

 All one can do is attempt to choose an allocation method

that seems to provide a rational and reasonable method of
cost distribution.

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Methods of allocation of joint costs

 The most frequently used methods that are used to

allocate joint costs up to split-off point can be divided
into the following two categories:

 Methods based on physical measures such as

weight, volume, etc.

 Methods based on allocating joint costs relative to

the market values of the products.

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Methods of allocation of joint costs

 Let’s look at four methods that are used for allocating joint
costs using the information given in Example 8.1.

 Products X, Y and Z all become finished products at the

split-off point.

 We must decide how much of the R600 000 joint costs

should be allocated to each individual product.

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Methods of allocation of joint costs

 The R600 000 cannot be specifically identified with any of

the individual products, since the products themselves were
not separated before the split-off point.

 Some method must be used to split the R600 000 among

the products X, Y and Z so that inventories can be valued
and the profit for the period calculated.

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Methods of allocation of joint costs

During July, VN LTD, processes a basic raw material

through a manufacturing process that yield three
products, products X, Y, and Z. There were no opening
inventories, and the products are sold at split-off point
without further processing. We shall initially assume that
all output is sold during the period. Details of the
production process and the sales revenues are given
hereunder:
Joint costs R600,000
Product X, 40,000 units with sales value of R7,50 per unit
Product Y, 20,000 units with sales value of R25 per unit
Product Z, 60,000 units with sales value of R 3,33 per
unit

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Physical measures method

 Joint costs are allocated in proportion to the volume .

 Each product is assumed to receive similar benefits from
the joint cost,
 Charged with its proportionate share of the total costs.
 The cost allocations using this method are shown below:

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Physical measures method
Product Units Proportion Joint costs Cost per
produced to total allocated unit
R
X 40,000 40/120 200,000 5
Y 20,000 20/120 100,000 5
Z 60,000 60/120 300,000 5
120,000 600,000

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Physical measures method
Product Sales value Total costs Profit or Profit
(loss) Margin %
R R R
X 300,000 200,000 100,000 33.33
Y 500,000 100,000 400,000 80
Z 200,000 300,000 (100,000) (50)
1,000,000 600,000 600,000 40

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Physical measures method
 the allocation of the joint costs bears no relationship to the revenue
producing power of the individual products.

 Product Z is allocated with the largest share of the joint costs but has
the lowest total sales revenue;

 Product Y is allocated with the lowest share of the joint costs but has
the highest total sales revenue.

 This illustrates a significant problem with the physical measures

method.

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Physical measures method

 A further problem is that the joint products must be

measurable by the same unit of measurement.

 Sometimes, the products emerging from the joint

process consist of solids, liquids and gases, and it can
be difficult to find a common base to measure them on.

 The main advantage of using the physical measures

method is simplicity.
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Sales value at split-off point
method
 Joint costs are allocated to joint products in proportion to the
estimated sales value of production.

 A product with higher sales value will be allocated a higher proportion

of the joint costs.

 To a certain extent, this method could better be described as a

means of apportioning profits or losses according to sales value,
rather than a method for allocating costs.

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Sales value at split-off point
method
 This method allocates joint costs based on a product’s ability to
absorb the joint costs, but it can itself be criticized because it
assumes that sales revenue determines prior costs.

 This can result in an unprofitable product with low sales revenue

being allocated with a small share of joint cost, thus mistakenly
giving the impression that it is generating profits.

 Using the information in Example 8.1, the allocations under the sales
value method would be as follows:

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Sales value at split-off point
method
Product Units Sales value Proportion Joint costs
produced of sales allocated
value to
total
R R R
X 40,000 300,000 30 180,000
Y 20,000 500,000 50 300,000
Z 60,000 200,000 20 120,000
120,000 1,000,000 100 600,000

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Sales value at split-off point
method – Revised product profit
Product Sales value Total costs Profit/(loss) Profit
R R R margin
%
X 300,000 180,000 120,000 40
Y 500,000 300,000 200,000 40
Z 200,000 120,000 80,000 40
1,000,000 600,000 400,000

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Net realizable value method
 We assumed that all products are sold at the split-off point and that no
additional costs are incurred beyond that point.

 In practice, it is likely that joint products will each require further processing
after the split-off point, and market values may not exist for the products
before this processing has taken place.

 To estimate the sales value at the split-off point, it is therefore necessary to

use the estimated sales value at the point of sale and work backwards.

 This method is called the net realizable value method. The net realizable
value at split-off point can be estimated by deducting the further processing
costs from the sales revenues.

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Net realizable value method
 The joint costs are now allocated in proportion to each product’s net
realizable value at split-off point.

 This approach is illustrated with the data given in Example 8.2, which
are the same as Example 8.1 except that further processing costs
beyond split-off point are now assumed to exist.

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Net realizable value method

ssume the same situation as Example 8.1

EXAMPLE 8.2
A except that further processing costs now
apply. Details of the production process and sales
revenues are given in the following diagram:

Further processing costs R80000

Product X, sales value

Joint costs R600000 R300000

Further processing costs R100000
Product Y, sales value
R500000
Further processing costs R20000
Product Z, sales value
R200000
Split-off point

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Net realizable value method
Product Sales Cost Estimated Proportion Joint Profit Gross
value beyond net to total costs profit
split-off realizable allocated margin
point value at
split-off
point
R R R % R R R
X 300,000 80,000 220,000 27,5 165,000 55,000 18.33

Y 500,000 100,000 400,000 50 300,000 100,000 20.00

Z 200,000 20,000 180,000 22,5 135,000 45,000 22.50

1,000,000 200,000 800,000 100 600,000 200,000 20.00

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Constant gross profit percentage
method
 When joint products are subject to further processing after split-off point
and the net realizable method is used, the gross profit percentages are
different for each product.

 In the example above , they are 18.33 per cent for product X, 20 per cent
for Y and 22.5 per cent for Z.

 It could be argued that, since the three products arise from a single
productive process, they should earn identical gross profit percentages.

 The constant gross profit percentage method allocates joint costs so that
the overall gross profit percentage is identical for each individual product.

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Constant gross profit percentage
method
 The joint costs would be allocated in such a way that the resulting
gross profit percentage for each of the three products is equal to the
overall gross profit percentage of 20 per cent.

 Note that the gross profit percentage is calculated by deducting the

total costs of the three products (R800 000) (R600,000 + R200,000)
from the total sales (R1 000 000) and expressing the profit (R200
000) as a percentage of sales (i.e., 20 per cent). The calculations are
on the next slide:

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Constant gross profit percentage
method
Product X Product Y Product Z Total
R R R R
Sales value 300,000 500,000 200,000 1,000,000

Gross profit (20%) 60,000 100,000 40,000 200,000

Cost of goods sold 240,000 400,000 160,000 800,000

Less separable further 80,000 100,000 20,000 200,000

processing costs
Allocated joint costs 160,000 300,000 140,000 600,000

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Constant gross profit percentage
method
 Gross profit percentage of 20 per cent is computed for each product.

 The additional further processing costs for each product are then
deducted, and the balance represents the allocated joint costs.

 The constant gross profit percentage method assumes that there is a

uniform relationship between cost and sales value for each individual
product.

 However, this assumption is questionable, since we do not observe

identical gross profit percentages for individual products in multi-product
companies that do not involve joint costs.
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Comparison of methods

 What factors should be considered in selecting the most appropriate method of

allocating joint costs?

 The cause-and-effect criterion cannot be used because there is no cause-and

effect relationship between the individual products and the incurrence of joint
costs.

 Joint costs are caused by all products and not by individual products.

 Where cause-and-effect relationships cannot be established, allocations should be

based on the benefits received criterion.

 If benefits received cannot be measured, costs should be allocated based on the

principle of equity or fairness.
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Comparison of methods

 The net realizable method and the sales value at split-off point
are the methods that best meet the benefits received criterion.

 If sales values at the split-off point exist, he sales at split-off point

method has the added advantage of simplicity.

 Difficult to estimate the net realizable value in industries where there

are numerous subsequent further processing stages and multiple
split-off points.

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Comparison of methods
Advantage and disadvantages of the different methods

Method Advantages Disadvantages

Physical Simple to operate where there is a common  Can distort profit reporting and
measurement unit of measurement inventory valuation
 Can be difficult to find a
common unit of measurement

Sales value at split-off Provides more realistic inventory valuations  Assumes that sales value
point determines prior costs
 Assumes that a sales value at
split-off point can be
determined

Net realizable value  Takes further processing costs into account  Can be difficult to calculate for
a complex process with many
 Simple to apply if there is only one split-off split-off points
point

Constant gross profit Appropriate only if a constant gross profit for  Only appropriate if a constant
percentage each joint product is a logical assumption gross profit for each product
makes sense 39
Irrelevance of joint cost
allocations for decision-making
 Joint product costs that have been computed for inventory valuation are normally inappropriate for
decision-making.

 Only relevant costs should be used and that these represent the incremental costs relating to a
decision.

 Costs that will be unaffected by a decision are classed as irrelevant.

 Joint cost allocations are thus irrelevant for decision-making.

 Consider the information presented in Example 8.3, which shows the additional revenue and costs
involved in converting product Y into product Z.

 A joint cost of R1 000 000 will be incurred irrespective of which decision is taken and is not relevant
for this decision.

 The information that is required for the decision is a comparison of the additional costs with the
additional revenues from converting product Y into product Z.

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Irrelevance of joint cost
allocations for decision-making
EXAMPLE 8.3

he Adriatic Company incurs joint product costs of R1 000 000 for the production of two joint products,

T X and Y. Both products can be sold at split-off point. However, if additional costs of R60 000 are incurred
on product Y then it can be converted into product Z and sold for R10 per unit. The joint costs and the sales
revenue at split-off point are illustrated in the following diagram:

Joint product cost Sale of 50 000 units of

R1 000 000 product X at R16 per unit: R800 000

Sale of 50 000 units of

Split-off point product Y at R8 per unit: R400 000

Total sales revenue R1 200 000

1. You are requested to advise management whether or not product Y should be converted into product Z.

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Irrelevance of joint cost
allocations for decision-making
Additional revenues and costs from converting product Y into
product Z
R
Additional revenue (50,000 x R2) 100,000
Additional conversion costs 60,000
Additional profit from conversion 40,000

42
Irrelevance of joint cost
allocations for decision-making
Proof of additional profits

Convert to Do not
product Z convert
R R
Sales 1,300,000 1,200,000

Total costs (1,060,000) (1,000,000)

Profit 240,000 200,000

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Accounting for by-products

 By-products are products that have a minor sales value and that emerge incidentally from
the production of the major product.

 As the major objective of the company is to produce the joint products, it can justifiably be
argued that the joint costs should be allocated only to the joint products

 The by-products should not be allocated with any portion of the joint cost that are incurred
before the split-off point.

 Any further costs that are incurred in producing by-products after the split-off point can
justifiably be charged to the by-product, since such costs are incurred for the benefit of the
by-product only.

 By-product revenues or by-product net revenues should be deducted from the cost of the
joint products or the main product from which it emerges.
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Accounting for by-products –
Example 8.4

EXAMPLE 8.4

he Neopolitan Company operates a manufacturing process that produces joint products A and B and by-

T product C. The joint costs of the manufacturing process are R3 020 000, incurred in the manufacture of:

Product A 30 000kg
Product B 50 000kg
By-product C 5 000kg

By-product C requires further processing at a cost of R1 per kg, after which it can be sold at R5 per kg.

45
Accounting for by-products

 None of the joint costs shown in Example 8.4 is allocated to the by-
product but the further processing costs of R5000 (5000kg x R1) are
charged to the by-product.

 The net revenues from the by-product of R20 000 (sales revenue of
R25 000 less further processing costs of R5000) are deducted from
the costs of the joint process (R3 020 000).

 Thus, joint costs of R3 000 000 will be allocated to joint products A

and B using one of the allocation methods described in this chapter.
The accounting entries for the by-product will be as follows:
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Accounting for by-products
Accounting entries for by products
R R

Dr By-product inventory (5,000 x R4) 20,000

Cr Joint Process WIP Account 20,000

With the net revenue due from the by-product

Dr By-product inventory 5,000

Cr cash 5,000

With separable manufacturing costs incurred

Dr Cash 25,000

Cr By Product inventory 25,000

With the value of by-products sales for the period

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Reference

Management and Cost Accounting in South Africa

Collins Drury, 1st Edition - Chapter 8

48
End of Lecture

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