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Joint Cost Allocation A. Characteristics--a common manufacturing process simultaneously produces two or more products from a common input 1. Joint Costs--joint costs are the costs of the common manufacturing process 2. Joint Products--joint products are the products produced from a common input and a common manufacturing process a. By-products--by-products are joint products that are relatively minor in quantity and/or value 3. Split-off Point--the split-off point is the stage of the common manufacturing process where the joint products are separated B. Joint Cost Allocation--joint costs need to be allocated to the joint products for various reasons (such as inventory valuation for financial accounting purposes, measuring profitability of joint products, pricing decisions, cost reimbursement, etc.) 1. Physical Quantities Method--joint costs are allocated to the joint products based on their relative physical measure (such as volume, weight, etc.) a. Illustration--a corporation incurred joint costs of $2,400 in manufacturing Product A and Product B to the split-off point; Product A weighed 700 pounds and had a sales value at the split-off point of $1,800; Product B weighed 300 pounds and had a sales value at the split-off point of $1,200 Cost Allocation: Product A = 700 / (700 + 300) x 2,400 = 1,680 Product B = 300 / 1,000 x 2,400 = 720 2,400 Income Statement: Product A Product B Total _ Sales 1,800 1,200 3,000 Cost of Goods Sold 1,680 720 2,400 Gross Margin 120 480 600 Gross Margin %: Product A = 120 / 1,800 = 7% Product B = 480 / 1,200 = 40% Total = 600 / 3,000 = 20% 2. Sales Value Method a. Net Realizable Value Method--if the sales value at the split-off point is known, joint costs are allocated to the joint products based on their relative sales value at the split-off point 1) Illustration--a corporation incurred joint costs of $2,400 in manufacturing Product A and Product B to the split-off point; Product A weighed 700 pounds and had a sales value at the split-off point of $1,800; Product B weighed 300 pounds and had a sales value at the split-off point of $1,200 Cost Allocation: Product A = 1,800 / (1,800 + 1,200) x 2,400 = 1,440 Product B = 1,200 / 3,000 x 2,400 = 960 2,400 Income Statement: Product A Product B Total _ Sales 1,800 1,200 3,000 Cost of Goods Sold 1,440 960 2,400 Gross Margin 360 240 600 Gross Margin %: Product A = 360 / 1,800 = 20% Product B = 240 / 1,200 = 20% Total = 600 / 3,000 = 20% b. No Sales-value at Split-off Point--the sales value at the split-off point for one or more of the joint products is not known 1) Estimated Net Realizable Value Method--sales value at the split-off point of the joint products is estimated by taking the sales value of each joint product at the first point at which the products can be sold and deducting the processing costs that must be incurred after the split-off point up to the first point at which the products can be sold, and then joint costs are allocated to the joint products based on their relative estimated sales value at the split-off point a) Illustration--a corporation incurred joint costs of $2,400 in manufacturing Product A and Product B to the split-off point; Product A weighed 700 pounds and had a sales value of $3,600 after incurring additional processing costs of $675; Product B weighed 300 pounds and had a sales value of $1,400 after incurring additional processing costs of $425 Estimated Net Realizable Value: Product A = 3,600 – 675 = 2,925 Product B = 1,400 – 425 = 975 Cost Allocation: Product A = 2,925 / (2,925 + 975) x 2,400 = 1,800 Product B = 975 / 3,900 x 2,400 = 600 2,400 Cost of Goods Sold: Product A = 1,800 + 675 = 2,475 Product B = 600 + 425 = 1,025 Income Statement: Product A Product B Total _ Sales 3,600 1,400 5,000 Cost of Goods Sold 2,475 1,025 3,500 Gross Margin 1,125 375 1,500 Gross Margin %: Product A = 1,125 / 3,600 = 31% Product B = 375 / 1,400 = 27% Total = 1,500 / 5,000 = 30% 2) Constant Gross Margin Percentage Method--under the constant gross margin percentage method joint costs are allocated to the joint products in a way that results in the same gross margin percentage for each joint product a) Computation I) Total Gross Margin Percentage--the gross margin percentage for all of the joint products is computed by dividing the excess of the sales value of all the joint products at the first point at which the products can be sold over the sum of the joint costs and the processing costs that must be incurred after the split- off point up to the first point at which the products can be sold by the sales value of all the joint products at the first point at which the products can be sold II) Cost of Goods Sold--the cost of goods sold for each joint product is computed by multiplying the sales value for each joint product by one minus the total gross margin percentage for all the joint products III) Joint Cost Allocation-the joint costs allocated to each joint product is computed by subtracting the processing costs incurred after the split-off point for each joint product from its cost of goods sold b) Illustration--a corporation incurred joint costs of $2,400 in manufacturing Product A and Product B to the split-off point; Product A weighed 700 pounds and had a sales value of $3,600 after incurring additional processing costs of $675; Product B weighed 300 pounds and had a sales value of $1,400 after incurring additional processing costs of $425 Constant Gross Margin Percentage: Total Sales = 3,600 + 1,400 = 5,000 Total Cost of Goods Sold = 2,400 + 675 + 425 = 3,500 Total Gross Margin = 5,000 – 3,500 = 1,500 Total Gross Margin Percentage = 1,500 / 5,000 = 30% Cost of Goods Sold: Product A = (1 – 30%) x 3,600 = 2,520 Product B = 70% x 1,400 = 980 Cost Allocation: Product A = 2,520 - 675 = 1,845 Product B = 980 - 425 = 555 2,400 Income Statement: Product A Product B Total _ Sales 3,600 1,400 5,000 Cost of Goods Sold 2,520 980 3,500 Gross Margin 1,080 420 1,500 Gross Margin %: Product A = 1,080 / 3,600 = 30% Product B = 420 / 1,400 = 30% Total = 1,500 / 5,000 = 30% C. Special Considerations 1. Decision Making a. Short-run Decision--at the split-off point the decision to sell a joint product at the split-off point or to process the joint product beyond the split-off point before selling it is determined by comparing the additional revenue generated from processing the joint product beyond the split-off point with the additional costs from processing the joint product beyond the split-off point 1) Illustrations a) A corporation incurred joint costs of $4,600 in manufacturing Product A and Product B to the split-off point; Product A can be sold at the split-off point for $3,500 or for $5,000 after incurring additional processing costs of $1,200; Product B can be sold at the split-off point for $2,500 or for $3,000 after incurring additional processing costs of $700 Additional Profit From Processing: Product A = (5,000 – 3,500) – 1,200 = 300 Product A should be processed beyond the split- off point. Product B = (3,000 – 2,500) – 700 = (200) Product B should not be processed beyond the split-off point. Profit at Split-off Point = 3,500 + 2,500 – 4,600 = 1,400 Profit From Processing Product A = 5,000 + 2,500 – (4,600 + 1,200) = 1,700 b) A corporation incurred joint costs of $6,500 in manufacturing Product A and Product B to the split-off point; Product A can be sold at the split-off point for $3,500 or for $5,000 after incurring additional processing costs of $1,200; Product B can be sold at the split-off point for $2,500 or for $3,000 after incurring additional processing costs of $700 Additional Profit From Processing: Product A = (5,000 – 3,500) – 1,200 = 300 Product A should be processed beyond the split- off point. Product B = (3,000 – 2,500) – 700 = (200) Product B should not be processed beyond the split-off point. Profit at Split-off Point = 3,500 + 2,500 – 6,500 = (500) Profit From Processing Product A = 5,000 + 2,500 – (6,500 + 1,200) = (200) b. Long-run Decision-at the start of the manufacturing process the decision to manufacture or not is determine by comparing the total revenues generated from the manufacturing process with the total costs from the manufacturing process 1) Illustrations a) A corporation estimated that it will incur joint costs of $6,200 in manufacturing Product A and Product B to the split-off point; Product A can be sold at the split-off point for $3,500 or for $5,000 after incurring additional processing costs of $1,200; Product B can be sold at the split-off point for $2,500 or for $3,000 after incurring additional processing costs of $700 Additional Profit From Processing: Product A = (5,000 – 3,500) – 1,200 = 300 Product A should be processed beyond the split- off point. Product B = (3,000 – 2,500) – 700 = (200) Product B should not be processed beyond the split-off point. Profit at Split-off Point = 3,500 + 2,500 – 6,200 = (200) Profit From Processing Product A = 5,000 + 2,500 – (6,200 + 1,200) = 100 The joint products should be manufactured. b) A corporation estimated that it will incur joint costs of $6,500 in manufacturing Product A and Product B to the split-off point; Product A can be sold at the split-off point for $3,500 or for $5,000 after incurring additional processing costs of $1,200; Product B can be sold at the split-off point for $2,500 or for $3,000 after incurring additional processing costs of $700 Additional Profit From Processing: Product A = (5,000 – 3,500) – 1,200 = 300 Product A should be processed beyond the split- off point. Product B = (3,000 – 2,500) – 700 = (200) Product B should not be processed beyond the split-off point. Profit at Split-off Point = 3,500 + 2,500 – 6,500 = (500) Profit From Processing Product A = 5,000 + 2,500 – (6,500 + 1,200) = (200) The joint products should not be manufactured. 2. By-products--by product accounting attempts to reflect the economic relationship between the by-products and the joint products with a minimum of recordkeeping costs a. Sales Value of By-product Sold--the proceeds from the sale of the by-product are treated either as a reduction of cost of goods sold or as other revenue 1) Illustration--a corporation incurred joint costs of $16,000 in manufacturing Product A, Product B, and Product C to the split- off point; Product C is considered a by-product; joints costs are allocated to the joint products using their relative weights; Product A weighed 2,000 pounds and was processed beyond the split-off point at a cost of $4,000; Product B weighed 3,000 pounds and was sold at the split-off point; Product C weighed 500 pounds and had a estimated net realizable value of $1,000; 1,400 pounds of Product A were sold; 2,700 pounds of Product B were sold; 400 pounds of Product C were sold Cost Allocation: Product A = 2,000 / (2,000 + 3,000) x 16,000 = 6,400 Product B = 3,000 / 5,000 x 16,000 = 9,600 16,000 Cost of Goods Sold: Product A = 1,400 / 2,000 x (6,400 + 4,000) = 7,280 Product B = 2,700 / 3,000 x 9,600 = 8,640 Product C = 400 / 500 x 1,000 = ( 800) 15,120 b. Net Realizable Value--the estimated realizable value of the by- product manufactured is treated as a reduction of the joint costs 1) Illustration--a corporation incurred joint costs of $16,000 in manufacturing Product A, Product B, and Product C to the split- off point; Product C is considered a by-product; joints costs are allocated to the joint products using their relative weights; Product A weighed 2,000 pounds and was processed beyond the split-off point at a cost of $4,000; Product B weighed 3,000 pounds and was sold at the split-off point; Product C weighed 500 pounds and had a estimated net realizable value of $1,000; 1,400 pounds of Product A were sold; 2,700 pounds of Product B were sold; 400 pounds of Product C were sold Cost Allocation: Product A = 2,000 / (2,000 + 3,000) x (16,000 – 1,000) = 6,000 Product B = 3,000 / 5,000 x 15,000 = 9,000 15,000 Cost of Goods Sold: Product A = 1,400 / 2,000 x (6,000 + 4,000) = 7,000 Product B = 2,700 / 3,000 x 9,000 = 8,100 15,100