In a sense, joint costs are sunk costs with respect to this decision, and will not influence future processing decisions. Thus joint costs incurred prior to the split-off point are irrelevant to the decision whether to process further after the split-off point. The sales value method allocates joint costs based on the relative sales value of each product at the split-off point. The costs allocated to joint products and by-products should have no bearing on the pricing of these products, since the costs have no relationship to the value of the items sold.
- By-product costing reduces the cost of the main products by the net realizable value of the by-products or credits the income from the by-products to a separate account.
- For example, in refining crude oil to produce gasoline to fuel cars and trucks, the refining process will create lubricants, fertilizers, petrochemicals, and other kinds of fuels.
- The cost accountant must also ensure that the allocation method used is consistent with IRS regulations.
- The net realizable value method allocates the joint costs in proportion to the estimated sales value of each product after deducting any further processing costs.
- The costs incurred up to the split-off point are considered joint costs and need to be allocated to the joint products for the purpose of accounting and decision-making.
The method chosen to allocate the joint costs among the joint products can significantly impact the reported cost and profitability of each product. Therefore, the allocation method should be chosen carefully and understood by those using the cost information for decision-making purposes. Both methods deal with multiple products that arise from a single raw material or joint process. Both methods require a split-off point to separate the products and determine their costs and revenues.
For example, suppose we have a company that expands from selling one product to two similar products. These separable product costs are identifiable with the individual product and generally need no allocation. The joint product cost results from the creation of two or more different products from a single cost factor. Failure to comply with these requirements can result in fines, penalties, and legal issues.
Once the costs have been allocated appropriately, the cost accountant can determine the profitability of each joint product and the by-product. This information can be used to decide which products to produce and sell and can also help identify opportunities to increase profitability. For example, if the wood chips have a value of $20 per batch, and 10% of the logs are turned into wood chips, then the cost accountant would allocate $2 of the total joint costs to the wood chips.
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Since the refining process requires heat, the excess heat can be used to create steam for electricity generation that more than meets the refinery’s needs and may be sold to an electric utility. When multiple products occur at the result of a combined process, they are called joint productsThe result of a combined production process that creates a natural opportunity for an economy of scope. If the total value of the joint product is significant, then additional analytical detail can improve decision making by management. To ensure compliance with tax regulations, the cost accountant must ensure that the allocation of joint and by-product costs accurately reflects the costs incurred in producing the goods sold. The cost accountant must also ensure that the allocation method used is consistent with IRS regulations.
The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Physical relationships that necessitate simultaneous production serve as a link between numerous products. An increase in one product’s output will increase the quantity of the other products, or vice versa, but not necessarily in the same proportion. These materials were downloaded from PwC’s Viewpoint (viewpoint.pwc.com) under license. If it’s not possible to determine the sale price of each product at the split-off point, the gross margin method may be the only option.
Example of Joint Product Costing
These resulting products are joint products because they are all derived from the same initial process of producing and collecting milk. They cannot be produced independently – you can’t produce cream, for example, without also producing skimmed milk during the separation process. The situation is quite different for any costs incurred from the split-off point onward.
Prior to the split-off point, all costs incurred are sunk costs, and as such have no bearing on any future decisions – such as the price of a product. Cost accountants must consistently use the same allocation method to ensure comparable financial statements. It may be difficult to compare the financial statements if different allocation methods are used for joint and by-product costs from year to year. In summary, accurately identifying joint products and by-products is essential for cost accountants to allocate costs appropriately and determine the profitability of each product. Joint products are two or more products that are generated within a single production process. This method also ensures that joint costs allocated to each product will not exceed sales revenue for each product (unless total joint costs are higher than total revenue).
Definition of Joint Product
Notice that the split-off pointThe point at which identifiable joint products emerge from the production process. The issue is how to allocate joint costs—the $250,000 in production costs incurred prior to the split-off point—to the resulting joint products. For example, suppose a company produces multiple products from a common set of resources. In that case, the cost accountant might choose the sales value at the split-off method to allocate joint costs based on the relative sales value of each product. The sales value at the split-off method allocates joint costs based on the relative sales value of each joint product at the point where they are separated from each other in the production process.
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For example, a meat processing plant that produces beef cuts as the main product and beef bones as a by-product might use the net realizable value method to allocate by-product costs based on the net realizable value of the beef bones. By-products are products that are produced alongside the main product in the manufacturing process. Joint products and by-products have their own cost components, and cost accountants must accurately identify them to allocate costs appropriately.
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This typically occurs when a raw material is transformed into multiple end products, with each of these products being of significant value. The first approach allocates costs based on estimated gross margins; the second approach allocates costs based on the sales value of the products. Although Grade B lumber appears to be unprofitable, elimination of Grade B lumber sales would not increase overall profit for Oregon Lumber. Thus elimination of Grade B lumber sales would result in a decrease in overall profit of $60,000. The $62,500 in joint cost allocated to Grade B lumber would simply be reallocated to Grade A lumber. The joint cost is incurred upto the split-off point (the point at which various products are separated).
The cost of this single input and the related manufacturing process costs are called joint costs. Suppose the refinery incurs costs of $10 million to purchase and process the crude oil up to the split-off point, where it is separated into https://business-accounting.net/ different products. Now these $10 million of joint costs need to be allocated to gasoline, diesel, and lubricants. A second type of cost savings occurs from doing similar activities in larger volume and reducing per unit variable costs.
At some point, the complexity of trying to administer a firm with too many goods and services will offset any cost savings, particularly if the goods and services share little in terms of production resources or processes. However, sometimes firms discover scope economies that are not so obvious and can realize increased economic profits, at least for a time until the competition copies their discovery. Most businesses provide multiple goods and services; in some cases, the number of goods and services is quite large. Whereas the motivation for providing multiple products may be driven by consumer expectations, a common attraction is the opportunity to reduce per unit costs. When a venture can appreciate such cost savings, the opportunity is called an economy of scopeThe ability of a business venture to achieve cost savings by providing multiple goods and services.. Separating by-product costs is important for accurately determining the cost of production for the main product and for the by-product.