Reviewer Joint And Byproduct Finals.docx

Accounting for Joint Products and By-Products A single production process may yield several different products. When two or more product, both of significant value, results from a single production process, they are called joint products. A joint product is different from a by-product, because a by-product has insignificant value compared to the main product or products. For income and inventory costing purposes, the allocation of costs to joint products and by-products is necessary. • Joint Products Joint Products are individual products, each with significant sales values, which are produced simultaneously from the same raw materials and/or manufacturing process . • Joint Products The basic characteristic of joint products are: • Manufacturing of joint products always has a split-off point (point of separation) in which separate products emerge, which can be sold as is or processed further. Cost incurred after splitoff point do not cause allocation problems since they can be identified with the specific products. • None of the joint products is significantly greater in value than other joint products . This characteristics distinguishes joint products from by-products. • Joint products require simultaneous common processing. Processing of one of the joint products results in the processing of all the other joint products at the same time. • Joint Costs and the Split-Off Point Joint costs or common costs consist of direct materials, direct labor, and manufacturing overhead incurred from the start of the process up to the point of separation (split-off point). These costs are indivisible, because they cannot be identified to any of the products being simultaneously produced. Additional processing costs (sometimes called further processing costs or separable costs) are costs incurred by each product, after they emerged from the same raw material. Additional processing costs consist also of additional materials, direct labor, and manufacturing overhead incurred after the split-off point. • Joint Costs and the Split-Off Point

• Methods for Allocating Joint Costs Three methods is usually used to allocate joint cost to individual products: • The physical measures method, such as weight (i.e., kilograms) or volume (i.e., cubic feet)/ • The sales value at split-off point method (relative sales value), set to yield a uniform rate of gross profit. • The adjusted sales value method (Net Realizable Value), considering additional processing costs. • Methods for Allocating Joint Costs Case 1: Joses’s Diary Products purchases raw milk from individual farms and processes it until the split-off point, when two products – cream and liquid skimemerge. These two products are sold to a company, which markets and distributes them to supermarket and other retail stores Summary Data for April 2014 are: • Raw milk processed, 55,000 gallons; 5,000 gallons are lost in the production process due to evaporation, spillage, and the like, yielding 12,500 gallons of cream and 37,500 gallons of liquid skim. • The production data, sales and inventories are as follows.

• Methods for Allocating Joint Costs The following questions depict the relationships in the above illustration: • How much of the P200,000 joint costs should be allocated to the cost of goods sold of 10,000 gallons of cream and 15,000 of liquid skim? • How much should be allocated to the ending inventory of 2,500 gallons of cream and 22,500 gallons of liquid skim? The joint production costs of P200,000 cannot be traced to either product. That’s because the products are not separated until the split-point. To determine the costs of cream and liquid skim sold different allocation basis can be used.

Physical Measures Method This method allocates joint costs to joint products on the basis of the relative weight, volume, or other physical measure at the split-off point of the production process. The P200,000 joint costs produced 12,500 gallons of cream and 37,500 gallons of liquid skim. Using the number of gallons produced as the physical measure, joint costs are allocated as follows:

When the sales value is known at the split-off point, the total joint cost is allocated among the joint products using the following formula:

Jose Dairy Products, Income Statement For April 2014

Jose Dairy Products Income Statement for April 2014

Note the following features of the physical measures method: • The physical measure in unit (the gallon) is easy to use because the products are measured in gallons. • The joint cost is easily allocated between the two products. • Unit cost of all the products are the same, because they were computed by dividing the total cost by the total units, • No consideration is given to relative sales value, special processing or handling required, the content of the product, or other special characteristics • Not all cost are directly related to physical units • Sales Value at Split-off Point Method This method allocates joint costs to joint products on the basis of their relative sales value at the split-off point. This method uses the sales value of the entire production of the accounting period, because joint costs are incurred on all units produced, not just on those sold in the current period.

*Units produced x unit sales value at split-off point.

Note the following features of the sales value at split-off point method: Cost are allocated to products in proportion to their expected revenues. • The cost-allocation base (total sales value at split-off point) is expressed in terms of a common denominator (the amount of revenues) that is systematically recorded in the accounting system. • This method needs the market selling prices for all products at the split-off point. • This method always yield the same rate of gross profit for the individual products when there are no beginning inventories and all products are sold at the split-off point. • This method is straightforward. Adjusted Sales Value Method If the joint products must be process further before sale, the sale value at split-off point method of allocation does not measure the true value of the products at the point of separation. The additional processing costs must be deducted from the sales value

before the cost allocation is made . Similarly, if the costs of selling the products vary widely, it may be desirable to deduct the estimated selling cost from the sales prices in order to arrive at the net or adjusted relative sales value to use as the basis of allocation. Under this method the joint cost is allocated to the joint products using the following formula.

Adjusted Sales Value Method Assume the same data as in previous illustration except that both cream and liquid skim can be processed further: • Cream to Whipping Cream: 12,500 gallons of cream are further processed to yield 10,000 gallons of whipping cream at additional processing costs of P140,000. Whipping cream, sells for P25 per gallon. • Liquid Skim to Condensed Milk: 37,500 gallons of liquid skim are further processed to yield 25,000 gallons of condensed milk at additional processing costs of P260,000. Condensed milk sells for P22 per gallon. Sales during the period were 6,000 gallons of whipping cream and 22,500 gallons of condensed milk. The ending inventories are as follows: Raw milk 0 gallons Cream 0 gallons Liquid skim 0 gallons Whipping cream 4,000 gallons Condensed milk 2,500 gallons There are no beginning inventories.

Adjusted Sales Value Method The following are the features of the adjusted sales value method (net realizable method): • This method is usually used only when the sales value at split-off point of one or more products is not known. • The allocations are very similar to those made when the sales value at split-off point is used. • The procedures involved are simple and relatively easy to apply. • The costs usually present the true picture of the values at the point of separation of the products. • The cost allocations are still derived from the selling or market price, which may have little or no relationship to the actual cost Jose Dairy Products Income Statement for April 2014

Choosing a Method of Cost Allocation Which method of allocating joint costs should be used? Use the sales value at split-off method when selling price is available (even if further processing is done). Reasons • It measures the value of the joint product immediately at the end of the joint process. • Does not require information on the processing steps after split-off point, if there is further processing. • Have a meaningful basis to allocate joint costs to products, which are revenues. • It is simple to apply. Accounting for By-Products Joint production process may yield not only joint products but also by-products. By-products are those products of limited sales value produced simultaneously with products of greater sales value, known as the main

or principal products. Main products are usually produced in much greater quantity than by-products. By-product, like joint or main products are produced from the same raw materials and or common manufacturing process. Joint costs are not directly traceable to either main products or by-products. Since by products are generally of secondary importance in production, cost allocation methods, differ from those used for joint products. Two by-products accounting methods can be used as follows: Method A: By-products are recognized when sold. This method is used when by-products are considered of minor importance and does not require additional processing costs. Net revenue from the sale of byproduct (sales value less selling costs) may be treated as: • Addition to revenue from the sale of the main product or as other income, and all manufacturing costs are applied to the main product. • Reduction from the cost of the main product. Method B: By-products are recognized when produced. This method is used when by-product are considered important and therefore requires additional processing costs. Two basic accounting methods can be used when by-products are recognized at time when production is completed. • The net realizable value of the completed byproduct (estimated sales value less estimated additional costs and selling costs) is charged to By-product inventory and deducted from the total manufacturing costs. No part of the joint costs is allocated to the by-product. • Part of the joint costs is allocated to the byproduct using the Normal Net Profit or Reversal Cost Method. By-products are also charged with any additional processing costs after separation. Illustration

Analysis of the Method • No cost is assigned or allocated to the byproduct. • The sale of the by-product has no effect on the cost of the main product. • The procedure is simple and practical and requires no computations of the cost of the byproduct.

Method B: By-Products Recognized When Produced This method recognizes by-products in the financial statements at the time production is completed. By-product is Recorded at its Net Realizable Value (NRV). This method recognizes the by-product in the financial statement - the 500 packs of potato skins – in the month it is produced is debited to By-product Inventory account and deducted from the costs of the main product. The journal entry to illustrate this method is: By-product Inventory – Potato Skins 20,000 Work in Process – Main product 20,000 To record net realizable value of the completed by-product (500 x P40)

McBee Company Income Statement for the Month of May 2014

Joint Costs Allocated to By-product Inventory (Reversal Cost Method) Under this method, the cost to be allocated to the byproduct is computed so that the by-product will yield the normal percentage of profit on sales on that the company makes, on the average. To illustrate this method, assume the following data for the by-products: • The potato skins by-product can be sold at P45 per pack. • The selling expenses are P5 per pack • The normal net profit of the business is 20% of sales. • Additional Manufacturing Costs after separation, materials,P3,000 and conversion costs. P2,000.

McBee Company Income Statement for the Month of May 2014