CHAPTER 15. COST ALLOCATION: JOINT PRODUCTS AND BY PRODUCTS
Goal: choose the cost allocation method that bet reflects how thte costs actually flow throughout a real
- Joint costs: costs of a production process that yields multiple main products simultaneously
- Product: any output that can be sold at full product cost plus profit or enables the company to
avoid purchasing direct materials.
- Joint products: products that have high sales values(main reason for production)
- By products: Products of relatively low sales value
- Scrap: minimal to zero sales value
- Splitoff point : juncture in a production process where two or more main products become
- Separable costs: full product costs of processing incurred by each identifiable product beyond
the splitoff point
Different reasons to allocate joint costs:
- Calculation of inventoriable costs and COGS for external financial statements and reports for
income tax authorities
- For internal financial reporting
- Cost reimbursement under contracts
- Customer profitability analysis
- Insurance settlement calculations
- Rate regulation when jointly produced subject to price regulations
- Contract litigation
APPROACHES TO ALLOCATING JOINT COSTS
- Physical measure method allocates joint costs on the basis of their relative proportions at the
split off point, using a common physical measure eg. Weights/ volume.
- Sales value at splitoff method allocates joint costs on the basis of the relative sales value at the
split off point of the total production in the accounting period for each product.
When it is further processed:
- Estimated NRV method allocates joint costs on the basis of the relative estimated net realizable
value ( expected final sales value in the ordinary course of business less expected separable costs
of production and marketing of the total production of the period)
- Constant gross margin percentage NRV method – reverse. Deduct gross margin and separable
cost from final sale value to come to a residual amount : the allocation of joint costs.
Product in the competitive market: company should follow a cost leadership strategy
Differentiated product: price is inelastic for consumers and value leadership is an appropriate strategy to
expand market share and profitability through growth. Consumers are willing to absorb additional cost. When using weights as measurement for allocation of joint cost: advantage:
- Observable, readily verifiable and economically plausible
- Average cost allocation rate is used.
Lower quantity with high sales price is possible in case of value leadership-> helps increase market share.
High quantity product – commodity for which customers set the price -> cost leadership strategy and
using average cost allocation rate will impair the corporation’s opportunity to recover full product costs
Sales value at splitoff method
Simple division of the joint cost pool by total revenue gives average cost allocation rate.-> allocation of
Often the gross margin percentage among the products will be the same.
However, revenue recognized during a specific accounting period, however must be reported product by
product. This method is verifiable and economically plausible but assumes all products are sold at
- Cost are allocated tp products in proportion to their revenue generating power ( expected
- Straightforward and intuitive
- Regulated markets provide shadow prices for these intermediate output, but competitive
markets do not.
Cons about physical measure
- Physical measure allocation method is less preferred than sales/ revenue based since there is no
relationship between the revenue and the weights, inconsistent with revenue objective and
distorts profit per unit.
- Physical measure is not straightforward
- In physical measure-By products and outputs with zero sales value will be excluded from the
physical measure used in the denominator.
DECIDING WHETHER TO SELL AT SPLITOFF OR PROCESS FURTHER
Compare the gross margins forecast by each method. The decision will have long term effects on the
company’s profitability. Goal is to implement the me