642
chApter 15
AllocAtion of Support-DepArtment coStS, common coStS, AnD revenueS
15-36 Support-department cost allocations; direct, step-down, and reciprocal methods. Ballantine
Corporation has two operating departments: Eastern Department and Western Department. Each of the
operating departments uses the services of the company’s two support departments: Engineering and
Information Technology. Additionally, the Engineering and Information Technology departments use the
services of each other. Data concerning the past year are as follows:
Support Departments
Budgeted overhead costs before
any interdepartment cost
allocations
Support work furnished:
By Engineering
Budgeted Engineering salaries
Percentage
By Information Technology
Budgeted IT service hours
Percentage
Required
Operating Departments
Information
Eastern
Western
Engineering Technology Department Department
Total
$300,000
$250,000
$650,000
$920,000 $2,120,000
—
—
450
15%
$60,000
30%
—
—
$50,000
25%
$90,000
45%
$200,000
100%
1,500
50%
1,050
35%
3,000
100%
1. What are the total overhead costs of the operating departments (Eastern and Western) after the
support-department costs of Engineering and Information Technology have been allocated using (a)
the direct method, (b) the step-down method (allocate Engineering first), (c) the step-down method
(allocate Information Technology first), and (d) the reciprocal method?
2. Which method would you recommend that Ballantine Corporation use to allocate service-department
costs? Why?
Cost Allocation:
Joint Products
and Byproducts
16
Many companies, such as petroleum refiners, produce and sell
two or more products simultaneously.
For example, ExxonMobil sells petroleum, natural gas, and raw liquefied petroleum gas
(LPG), which are produced when the company extracts and refines crude oil. Similarly,
health care providers offer multiple services, such as medical treatment, nursing care,
and rehabilitation, to patients. The question is, “How should these companies allocate
costs to ‘joint’ products and services?” Knowing how to allocate joint product costs
isn’t something that only for-profit businesses need to understand. It’s something
that charitable organizations have to deal with, too, especially in light of the increased
scrutiny placed on their spending choices by nonprofit watchdogs.
Joint-Cost AlloCAtion
And the Wounded WArrior ProJeCt1
Around the world, charities raise money from philanthropic donors to fulfill their missions. In the United States, the Wounded Warrior Project (WWP) raises money to
Learning Objectives
1
Identify the splitoff point in a jointcost situation and distinguish joint
products from byproducts
2
Explain why joint costs are allocated
to individual products
3
Allocate joint costs using four
methods
4
Identify situations when the
salesvalue at splitoff method is
preferred when allocating joint
costs
5
Explain why joint costs are irrelevant in a sell-or-process-further
decision
6
Account for byproducts using
twomethods
provide programs and services for wounded veterans of recent military campaigns.
While the organization is the largest and fastest-growing veterans’ charity in the United
States, taking in more than $372 million in 2015, WWP ousted its two top executives in
2016 over controversy about its joint-cost allocation.
U.S. accounting rules allow charities to classify certain fundraising mailings as a public-interest service if the solicitations are
educational and include a call to action beyond simply appealing
for money, such as contacting a public official. Those joint costs
must be allocated to either programs, fund-raising, or administration. In 2014, WWP reported that $190 million, or 76% of
its budget, went to veterans’ programs—a share that charity
watchdogs consider respectable. However, almost $41 million
of that amount was claimed as the educational component of
fund-raising requests. Without it, programming and services
would have accounted for only 60% of WWP’s budget.
Charities such as WWP believe that joint costs, if used appropriately, reward efficiency because charities can combine multiple goals into a single campaign and reflect that in its breakdown
of costs. Others argue that joint costs allow charities to overstate
1
Ricky Fitchett/ZUMA Wire/Alamy Stock Photo
Sources: Dave Phillips, “Wounded Warrior Project Spends Lavishly on Itself, Insiders Say,” The New York Times
(January 27, 2016); No author, “Wounded Warrior Veterans Aid Group Fires Executives Over Lavish Spending,”
Los Angeles Times (March 11, 2016); Bennett Weiner, “Can Mail Appeals Also Educate and Advocate?” BBB Wise
Giving Alliance, Wise Giving Guide (Spring 2013).
643
the program portion of its work, misleading donors into believing that more is being done for a
cause than is really the case.
In 2016, media reports surfaced WWP’s joint-cost allocation and some questionable expenses, including spending hundreds of thousands of dollars on public relations and lobbying campaigns to deflect criticism of its spending and to fight efforts to restrict how much charities such as
WPP spend on overhead. As a result, WPP fired its CEO and COO, publicly noting that it needed to
better monitor expenses and strengthen controls that had not kept pace with its rapid growth.
This chapter examines methods for allocating costs to joint products. We also examine how
cost numbers appropriate for one purpose, such as external reporting, may not be appropriate for
other purposes, such as decisions about the further processing of joint products.
Joint-Cost Basics
Learning
Objective
1
Identify the splitoff point in a
joint-cost situation
. . . the point at which two
or more products become
separately identifiable
and distinguish joint
products
. . . products with high sales
values
from byproducts
. . . products with low sales
values
Joint costs are the costs of a production process that yields multiple products simultaneously.
Consider the distillation of coal, which yields coke, natural gas, and other products. The
costs of this distillation are joint costs. The splitoff point is the juncture in a joint production
process when two or more products become separately identifiable. An example is the point
at which coal becomes coke, natural gas, and other products. Separable costs are all costs—
manufacturing, marketing, distribution, and so on—incurred beyond the splitoff point that
are assignable to each of the specific products identified at the splitoff point. At or beyond the
splitoff point, decisions relating to the sale or further processing of each identifiable product
can be made independently of decisions about the other products.
As the examples in Exhibit 16-1 show, the production processes in many industries simultaneously yield two or more products, either at the splitoff point or after further processing.
In each of these examples, no individual product can be produced without the accompanying
products appearing, although in some cases the proportions can be varied. Joint costing allocates the joint costs to the individual products that are eventually sold.
The outputs of a joint production process can be classified into two general categories:
outputs with a positive sales value and outputs with a zero sales value.2 For example, offshore
processing of hydrocarbons yields oil and natural gas, which have positive sales value; the
exhibit 16-1
Examples of JointCost Situations
Industry
Agriculture and
Food Processing Industries
Cocoa beans
Lambs
Hogs
Raw milk
Lumber
Turkeys
Extractive Industries
Coal
Copper ore
Petroleum
Salt
Chemical Industries
Raw LPG (liquefied petroleum gas)
Crude oil
Semiconductor Industry
Fabrication of silicon-wafer chips
2
Separable Products at the Splitoff Point
Cocoa butter, cocoa powder, cocoa drink mix, tanning cream
Lamb cuts, tripe, hides, bones, fat
Bacon, ham, spare ribs, pork roast
Cream, liquid skim
Lumber of varying grades and shapes
Breast, wings, thighs, drumsticks, digest, feather meal,
poultry meal
Coke, gas, benzol, tar, ammonia
Copper, silver, lead, zinc
Crude oil, natural gas
Hydrogen, chlorine, caustic soda
Butane, ethane, propane
Gasoline, kerosene, benzene, naphtha
Memory chips of different quality (as to capacity), speed, life
expectancy, and temperature tolerance
Some outputs of a joint production process have “negative” revenue when their disposal costs (such as the costs of handling nonsalable toxic substances that require special disposal procedures) are considered. These disposal costs should be added to the joint
production costs that are allocated to joint or main products.
AllocAting Joint costs
processing also yields water, which has zero sales value and is recycled back into the ocean.
The term product describes any output that has a positive total sales value (or an output that
enables a company to avoid incurring costs, such as an intermediate chemical product used as
input in another process). The total sales value can be high or low.
When a joint production process yields one product with a high total sales value, compared with the total sales values of other products of the process, that product is called a
main product. When a joint production process yields two or more products with high total
sales values relative to the total sales values of other products, those products are called joint
products. In contrast, products of a joint production process that have low total sales values
relative to the total sales value of the main product or of joint products are called byproducts.
Consider some examples. If timber (logs) is processed into standard lumber and wood
chips, standard lumber is a main product and wood chips are the byproduct because standard lumber has a high total sales value compared with wood chips. If, however, the logs are
processed into fine-grade lumber, standard lumber, and wood chips, fine-grade lumber and
standard lumber are joint products and wood chips are the byproduct. That’s because both
fine-grade lumber and standard lumber have high total sales values relative to wood chips.
Distinctions among main products, joint products, and byproducts are not so clear-cut in
practice. Companies use different thresholds for determining whether the relative sales value
of a product is high enough for it to be considered a joint product. Consider kerosene, obtained when refining crude oil. Based on a comparison of its sales value to the total sales values
of gasoline and other products, some companies classify kerosene as a joint product whereas
others classify it as a byproduct. Moreover, the classification of products—main, joint, or
byproduct—can change over time, especially for products such as lower-grade semiconductor
chips, whose market prices may increase or decrease by 30% or more in a year. When prices
of lower-grade chips are high, they are considered joint products together with higher-grade
chips; when prices of lower-grade chips fall considerably, they are considered byproducts. In
practice, it is important to understand how a specific company chooses to classify its products.
645
DecisiOn
Point
What do the terms joint
cost and splitoff point
mean, and how do joint
products differ from
byproducts?
Allocating Joint Costs
Before a manager is able to allocate joint costs, she must first look at the context for doing so.
Joint costs must be allocated to individual products or services for several purposes, including
the following:
■
■
■
3
Computing inventoriable costs and the cost of goods sold for external and internal reporting purposes. Recall from Chapter 9 that absorption costing is required for financial
accounting and tax reporting. This necessitates the allocation of joint manufacturing or
processing costs to products for calculating ending inventory values. In addition, many
firms use internal accounting data based on joint-cost allocations to analyze the profitability of their various divisions and evaluate the performance of division managers.
Reimbursing companies that have some, but not all, of their products or services reimbursed under cost-plus contracts with, say, a government agency. For example, the joint
costs incurred when multiple organs are removed from a single donor must be allocated
to various organ centers in order to determine reimbursement rates for transplants into
Medicare patients. In such cases, stringent rules typically specify the way in which joint
costs are assigned to the products or services covered by the agreements. That said, fraud
in defense contracting, which is often done via cost-plus contracts, remains one of the most
active areas of false claim litigation under the Federal False Claims Act. A common practice
is “cross-charging,” where a contractor shifts joint costs from “fixed-price” defense contracts to those that are done on a cost-plus basis. Defense contractors have also attempted to
secure contracts from private businesses or foreign governments by allocating an improper
share of joint costs onto the cost-plus agreements they have with the U.S. government.3
Regulating the rates or prices of one or more of the jointly produced products or services.
This issue is critical in the extractive and energy industries, in which output prices are
See, for example, www.dodig.mil/iginformation/IGInformationReleases/3eSettlementPR.pdf.
Learning
Objective
2
Explain why joint costs
are allocated to individual
products
. . . to calculate cost of
goods sold and inventory
and for reimbursements
under cost-plus contracts
and other types of claims
646
chApter 16
cost AllocAtion: Joint products And Byproducts
■
DecisiOn
Point
Concepts in Action: U.S.-South Africa Trade Dispute Over Joint-Cost Allocation outlines
another scenario in which joint-cost allocations are important and have also been the subject
of some controversy.
Why are joint costs
allocated to individual
products?
Learning
Objective
regulated to yield a fixed return on a cost basis that includes joint-cost allocations. In
telecommunications, a firm with significant market power has some products subject to
price regulation (e.g., interconnection) and other activities that are unregulated (such as
equipment rentals to end-users). In this case, joint costs must be allocated to ensure that
costs are not transferred from unregulated services to regulated ones.
For any commercial litigation or insurance settlement situation in which the costs of joint
products or services are key inputs.
3
Allocate joint costs using
four methods
. . . sales value at splitoff,
physical measure, net
realizable value (NRV), and
constant gross-margin
percentage NRV
Approaches to Allocating Joint Costs
Two approaches are used to allocate joint costs.
■
Approach 1. Allocate joint costs using market-based data such as revenues. This chapter illustrates three methods that use this approach:
1. Sales value at splitoff method
2. Net realizable value (NRV) method
3. Constant gross-margin percentage NRV method
cOncepts
in actiOn
U.S.-South Africa Trade Dispute
Over Joint-Cost Allocation
For 15 years, the United States and South Africa were embroiled in a
trade dispute over chicken. South African authorities, in response to
claims that American poultry farmers were “dumping” chicken meat
in South Africa by selling it at unfairly low prices, imposed tariffs on
chicken from the United States. The duties were so high that American
producers were locked out of the market entirely. The dispute focused on
differing consumer preferences and joint-cost allocation.
In South Africa, consumers prefer dark meat chicken (thighs and
legs), while Americans have a strong preference for white meat (breasts
and wings). As a result, American producers were able to sell certain dark
Vicki Beaver/Alamy Stock Photo
meat chicken products for a higher price in South Africa than they could
in America. With large amounts of U.S. dark meat chicken in the South
African market, officials believed that American producers were selling the meat at a price below the cost of production, a
violation of trade rules, and imposed 209 to 375 percent antidumping duties on U.S. chicken.
The United States rejected those claims, arguing that South African officials were ignoring the joint-cost allocation
methods of American producers. Until chicken parts are separated from each other, those parts incur joint costs of production. To determine the costs associated with certain chicken parts, such as thighs and legs, you have to allocate those joint
costs between all the parts of a chicken. American producers allocate joint costs based on the relative value of the different end products. The products that command a higher price are assigned a larger share of the joint costs. With dark meat
chicken products selling for less in America than white meat, those parts were assigned a smaller share of the joint costs—
the opposite of what would occur in South Africa!
In 2015, the United States and South Africa resolved the long-running trade war over chicken. Under the terms of the
settlement, South Africa agreed to establish a large quota for imports of U.S. chicken that are exempt from the antidumping duties. American producers were pleased, but they missed out on a 70% increase in South African chicken consumption
between 2000 and 2015. Today, the United States only supplies 3% of the country’s $340 million in annual chicken imports.
Sources: William Watson, “Antidumping Fowls Out: U.S.-South Africa Chicken Dispute Highlights the Need for Global Reform,” Cato Institute Free Trade
Bulletin (October 19, 2015); Neanda Slavaterra, “Poultry Dispute Threatens South African Trade with U.S.,” The Wall Street Journal (September 13, 2015).
ApproAches to AllocAting Joint costs
■
Approach 2. Allocate joint costs using physical measures, such as the weight, quantity
(physical units), or volume of the joint products.
In preceding chapters, we used the cause-and-effect and benefits-received criteria for guiding
cost-allocation decisions (see Exhibit 14-2, page 562). Joint costs do not have a cause-andeffect relationship with individual products because the production process simultaneously
yields multiple products. Using the benefits-received criterion leads to a preference for methods under approach 1 because revenues are, in general, a better indicator of benefits received
than physical measures. Mining companies, for example, receive more benefit from 1ton of
gold than they do from 10 tons of coal.
In the simplest joint production process, the joint products are sold at the splitoff point
without further processing. Example 1 illustrates the two methods that apply in this case:
the sales value at splitoff method and the physical-measure method. Then we introduce joint
production processes that yield products that require further processing beyond the splitoff
point. Example 2 illustrates the NRV method and the constant gross-margin percentage NRV
method. To help you focus on key concepts, we use numbers and amounts that are smaller
than the numbers that are typically found in practice.
The exhibits in this chapter use the following symbols to distinguish a joint or main product from a byproduct:
Joint Product or Main Product
Byproduct
To compare the methods, we report gross-margin percentages for individual products under
each method.
Example 1: Farmland Dairy purchases raw milk from individual farms and
processes it until the splitoff point, when two products—cream and liquid
skim—emerge. These two products are sold to an independent company,
which markets and distributes them to supermarkets and other retail outlets.
In May 2017, Farmland Dairy processes 110,000 gallons of raw milk. During
processing, 10,000 gallons are lost due to evaporation and spillage, yielding
25,000 gallons of cream and 75,000 gallons of liquid skim. The data are summarized as follows:
A
B
C
Joint Costs
1
Joint costs (costs of 110,000 gallons raw milk
2 and processing to splitoff point)
$400,000
3
4
5 Beginning inventory (gallons)
6 Production (gallons)
7 Sales (gallons)
8 Ending inventory (gallons)
9 Selling price per gallon
Cream
25,000
20,000
5,000
$
8
Liquid Skim
75,000
30,000
45,000
$
4
Exhibit 16-2 depicts the basic relationships in this example.
How much of the $400,000 joint costs should be allocated to the cost of goods sold of
20,000 gallons of cream and 30,000 gallons of liquid skim, and how much should be allocated
647
648
chApter 16
cost AllocAtion: Joint products And Byproducts
Joint Costs
$400,000
exhibit 16-2
Example 1: Overview of
Farmland Dairy
Cream
25,000 gallons
Raw Milk
110,000
gallons
Processing
Liquid
Skim
75,000 gallons
Splitoff
Point
to the ending inventory of 5,000 gallons of cream and 45,000 gallons of liquid skim? We begin
by illustrating the two methods that use the properties of the products at the splitoff point: the
sales value at splitoff method and the physical-measure method.
Sales Value at Splitoff Method
The sales value at splitoff method allocates joint costs to joint products produced during the
accounting period on the basis of the relative total sales value at the splitoff point. Using this
method for Example 1, Exhibit 16-3, Panel A, shows how joint costs are allocated to individual
products to calculate the cost per gallon of cream and liquid skim for valuing ending inventory.
This method uses the sales value of the entire production of the accounting period (25,000 gallons of cream and 75,000 gallons of liquid skim), not just the quantity sold (20,000 gallons of
cream and 30,000 gallons of liquid skim). The reason this method does not rely solely on the
quantity sold is that the joint costs were incurred on all units produced, not just the portion
sold during the current period. Exhibit 16-3, Panel B, presents the product-line income statement using the sales value at splitoff method. Note that the gross-margin percentage for each
product is 20% because the sales value at splitoff method allocates joint costs to each product
in proportion to the sales value of total production (cream: $160,000 , $200,000 = 80%;
liquid skim: $240,000 , $300,000 = 80%). Therefore, the gross-margin percentage for each
product manufactured in May 2017 is the same: 20%.4
Note how the sales value at splitoff method follows the benefits-received criterion of cost
allocation: Costs are allocated to products in proportion to their revenue-generating power
(their expected revenues). The cost-allocation base (total sales value at splitoff) is expressed
in terms of a common denominator (the amount of revenues) that is systematically recorded
in the accounting system. To use this method, selling prices must exist for all products at the
splitoff point.
Physical-Measure Method
The physical-measure method allocates joint costs to joint products produced during the
accounting period on the basis of a comparable physical measure, such as the relative weight,
quantity, or volume at the splitoff point. In Example 1, the $400,000 joint costs produced
25,000 gallons of cream and 75,000 gallons of liquid skim. Using the number of gallons produced as the physical measure, Exhibit 16-4, Panel A, shows how joint costs are allocated to
individual products to calculate the cost per gallon of cream and liquid skim.
4
Suppose Farmland Dairy has beginning inventory of cream and liquid milk in May 2017 and when this inventory is sold, Farmland
earns a gross margin different from 20%. Then the gross-margin percentage for cream and liquid skim will not be the same. The relative gross-margin percentages will depend on how much of the sales of each product came from beginning inventory and how much
came from current-period production.
ApproAches to AllocAting Joint costs
exhibit 16-3
Joint-Cost Allocation and Product-Line Income Statement Using Sales Value at Splitoff
Method: Farmland Dairy for May 2017
A
1
2
3
4
5
6
7
PANEL A: Allocation of Joint Costs Using Sales Value at Splitoff Method
Sales value of total production at splitoff point
(25,000 gallons 3 $8 per gallon; 75,000 gallons 3 $4 per gallon)
Weighting ($200,000 4 $500,000; $300,000 4 500,000)
Joint costs allocated (0.40 3 $400,000; 0.60 3 $400,000)
Joint production cost per gallon
($160,000 4 25,000 gallons; $240,000 4 75,000 gallons)
B
C
D
Cream
Liquid Skim
Total
$ 200,000
0.40
$ 160,000
$300,000
0.60
$240,000
$ 500,000
6.40
$
$
$ 400,000
3.20
8
9
10
11
12
13
14
15
16
PANEL B: Product-Line Income Statement Using Sales Value at Splitoff Method for May 2017
Revenues (20,000 gallons 3 $8 per gallon; 30,000 gallons 3 $4 per gallon)
Cost of goods sold (joint costs):
Production costs (0.40 3 $400,000; 0.60 3 $400,000)
Deduct ending inventory (5,000 gallons 3 $6.40 per gallon; 45,000 gallons 3 $3.20 per gallon)
Cost of goods sold (joint costs)
Gross margin
Gross margin percentage ($32,000 4 $160,000; $24,000 4 $120,000; $56,000 4 $280,000)
exhibit 16-4
2
3
4
5
Total
$ 280,000
160,000
32,000
128,000
$ 32,000
20%
400,000
176,000
224,000
$ 56,000
20%
240,000
144,000
96,000
$ 24,000
20%
Joint-Cost Allocation and Product-Line Income Statement Using Physical-Measure Method:
Farmland Dairy for May 2017
A
1
Cream
Liquid Skim
$160,000
$120,000
B
C
PANEL A: Allocation of Joint Costs Using Physical-Measure Method
Physical measure of total production (gallons)
Weighting (25,000 gallons 4 100,000 gallons; 75,000 gallons 4 100,000 gallons)
Joint costs allocated (0.25 3 $400,000; 0.75 3 $400,000)
Joint production cost per gallon ($100,000 4 25,000 gallons; $300,000 4 75,000 gallons)
Cream
25,000
0.25
$100,000
$ 4.00
Liquid Skim
75,000
0.75
$ 300,000
$ 4.00
D
PANEL B: Product-Line Income Statement Using Physical-Measure Method for May 2017
Revenues (20,000 gallons 3 $8 per gallon; 30,000 gallons 3 $4 per gallon)
Cost of goods sold (joint costs):
Production costs (0.25 3 $400,000; 0.75 3 $400,000)
Deduct ending inventory (5,000 gallons 3 $4 per gallon; 45,000 gallons 3 $4 per gallon)
Cost of goods sold (joint costs)
Gross margin
Gross margin percentage ($80,000 4 $160,000; $0 4 $120,000; $80,000 4 $280,000)
Cream
$160,000
Liquid Skim
$120,000
Total
$ 280,000
100,000
20,000
80,000
$ 80,000
50%
300,000
180,000
120,000
$
0%
400,000
200,000
200,000
$ 80,000
28.6%
Total
100,000
$ 400,000
6
7
8
9
10
11
12
13
14
Because the physical-measure method allocates joint costs on the basis of the number of
gallons, the cost per gallon is the same for both products. Exhibit 16-4, Panel B, presents the
product-line income statement using the physical-measure method. The gross-margin percentages are 50% for cream and 0% for liquid skim.
Under the benefits-received criterion, the physical-measure method is much less desirable
than the sales value at splitoff method. Why? Because the physical measure of the individual
products may have no relationship to their respective revenue-generating abilities. Consider
a mine that extracts ore containing gold, silver, and lead. Using a common physical measure
(tons) would result in almost all costs being allocated to lead, the product that weighs the
most but has the lowest revenue-generating power. This method of cost allocation is inconsistent with the main reason the mining company is incurring mining costs—to earn revenues
from gold and silver, not lead. When a company uses the physical-measure method in a
product-line income statement, products that have a high sales value per ton, like gold and
649
650
chApter 16
cost AllocAtion: Joint products And Byproducts
silver, would show a large “profit,” and products that have a low sales value per ton, like lead,
would show sizable losses.
Obtaining comparable physical measures for all products is not always straightforward.
Consider the joint costs of producing oil and natural gas; oil is a liquid and gas is a vapor.
To use a physical measure, the oil and gas need to be converted to the energy equivalent for
oil and gas, British thermal units (BTUs). Using physical measures to allocate joint costs may
require assistance from technical personnel outside of accounting.
Determining which products of a joint process to include in a physical-measure computation can greatly affect the allocations to those products. Outputs with no sales value (such
as dirt in gold mining) are always excluded. Although many more tons of dirt than gold are
produced, costs are not incurred to produce outputs that have zero sales value. Byproducts are
also often excluded from the denominator used in the physical-measure method because of
their low sales values relative to the joint products or the main product. The general guideline
for the physical-measure method is to include only the joint-product outputs in the weighting
computations.
try it!
16-1
Xavier Chemicals processes resin from fir trees into three products: printing inks,
varnishes, and adhesives. During June, the joint costs of processing were $480,000.
Additional information is given below:
Product
Printing inks
Varnishes
Adhesives
Units Produced
15,000 liters
15,000 liters
7,500 liters
Sales Value at Splitoff Point
$120,000
72,000
48,000
Determine the amount of joint cost allocated to each product if Xavier uses (a) the physical
measure method, and (b) the sales value at splitoff method.
Net Realizable Value Method
In many cases, products are processed beyond the splitoff point to bring them to a marketable
form or to increase their value above their selling price at the splitoff point. For example, when
crude oil is refined, the gasoline, kerosene, benzene, and naphtha must be processed further
before they can be sold. To illustrate, let’s extend the Farmland Dairy example.
Example 2: Assume the same data as in Example 1 except that both cream and
liquid skim can be processed further:
■
■
■
Cream S Buttercream: 25,000 gallons of cream are further processed
to yield 20,000 gallons of buttercream at additional processing costs of
$280,000. Buttercream, which sells for $25 per gallon, is used in the manufacture of butter-based products.
Liquid Skim S Condensed Milk: 75,000 gallons of liquid skim are further
processed to yield 50,000 gallons of condensed milk at additional processing costs of $520,000. Condensed milk sells for $22 per gallon.
Sales during May 2017 are 12,000 gallons of buttercream and 45,000 gallons
of condensed milk.
Exhibit 16-5, Panel A, depicts how (a) raw milk is converted into cream and liquid skim in the
joint production process and (b) how cream is separately processed into buttercream and liquid skim is separately processed into condensed milk. Panel B shows the data for Example 2.
The net realizable value (NRV) method allocates joint costs to joint products produced
during the accounting period on the basis of their relative NRV—final sales value minus
separable costs. The NRV method is typically used in preference to the sales value at splitoff
ApproAches to AllocAting Joint costs
PANEL A: Graphical Presentation of Process for Example 2
Example 2: Overview
of Farmland Dairy
Separable Costs
Joint Costs
$400,000
Raw Milk
110,000
gallons
exhibit 16-5
Cream
25,000 gallons
Further
Processing
$280,000
Buttercream
20,000 gallons
Liquid
Skim
75,000 gallons
Further
Processing
$520,000
Condensed
Milk
50,000 gallons
Processing
Splitoff
Point
PANEL B: Data for Example 2
A
B
C
Joint Costs
1
Joint costs (costs of 110,000 gallons raw milk
and processing to splitoff point)
Separable cost of processing 25,000 gallons
3 cream into 20,000 gallons buttercream
Separable cost of processing 75,000 gallons
4 liquid skim into 50,000 gallons condensed milk
D
E
Buttercream
Condensed Milk
$400,000
2
$280,000
$520,000
5
6
7
8
9
10
11
12
Beginning inventory (gallons)
Production (gallons)
Transfer for further processing (gallons)
Sales (gallons)
Ending inventory (gallons)
Selling price per gallon
Cream
25,000
25,000
$
8
Liquid Skim
75,000
75,000
$
4
Buttercream
20,000
Condensed Milk
50,000
12,000
8,000
25
$
45,000
5,000
$
22
method only when selling prices for one or more products at splitoff do not exist. Using this
method for Example 2, Exhibit 16-6, Panel A, shows how joint costs are allocated to individual products to calculate cost per gallon of buttercream and condensed milk. Panel B presents
the product-line income statement using the NRV method. The gross-margin percentages are
22.0% for buttercream and 26.4% for condensed milk.
The NRV method is often implemented using simplifying assumptions. For example,
even when the selling prices of joint products vary frequently, companies implement
the NRV method using a given set of selling prices throughout the accounting period.
Similarly, even though companies may occasionally change the number or sequence of processing steps beyond the splitoff point in order to adjust to variations in input quality or
local conditions, they assume a specific constant set of such steps when implementing the
NRV method.
Constant Gross-Margin Percentage NRV Method
The constant gross-margin percentage NRV method allocates joint costs to joint products
produced during the accounting period in such a way that each individual product achieves
an identical gross-margin percentage. The method works backward in that the overall gross
margin is computed first. Then, for each product, this gross-margin percentage and any
separable costs are deducted from the final sales value of production in order to back into the
651
652
chApter 16
cost AllocAtion: Joint products And Byproducts
exhibit 16-6
Joint-Cost Allocation and Product-Line Income Statement Using NRV Method: Farmland
Dairy for May 2017
A
1
2
3
4
5
6
7
8
9
B
C
D
PANEL A: Allocation of Joint Costs Using Net Realizable Value Method
Final sales value of total production during accounting period
(20,000 gallons 3 $25 per gallon; 50,000 gallons 3 $22 per gallon)
Deduct separable costs
Net realizable value at splitoff point
Weighting ($220,000 4 $800,000; $580,000 4 $800,000)
Joint costs allocated (0.275 3 $400,000; 0.725 3 $400,000)
Production cost per gallon
([$110,000 1 $280,000] 4 20,000 gallons; [$2 90,000 1 $520,000] 4 50,000 gallons)
Buttercream
Condensed Milk
Total
$500,000
280,000
$220,000
0. 275
$110,00 0
$1,100,000
520,000
$ 580,000
0.725
$ 290,000
$1,600,000
800,000
$ 800,000
$ 19.50
$
PANEL B: Product-Line Income Statement Using Net Realizable Value Method for May 2017
Revenues (12,000 gallons 3 $25 per gallon; 45,000 gallons 3 $22 per gallon)
Cost of goods sold:
Joint costs (0.275 3 $400,000; 0.725 3 $400,000)
Separable costs
Production costs
Deduct ending inventory (8,000 gallons 3 $19.50 per gallon; 5,000 gallons 3 $16.20 per gallon)
Cost of goods sold
Gross margin
Gross margin percentage ($66,000 4 $300,000; $261,000 4 $990,000; $327,000 4 $1,290,000)
Buttercream
$300,000
Condensed Milk
$ 990,000
Total
$1,290,000
110,000
280,000
390,000
156,000
234,000
$ 66,000
22.0%
290,000
520,000
810,000
81,000
729,000
$ 261,000
26.4%
400,000
800,000
1,200,000
237,000
963,000
$ 327,000
25.3%
$ 400,000
16.20
10
11
12
13
14
15
16
17
18
19
20
try it!
16-2
Red Stripe Company processes tomatoes into ketchup, tomato juice, and canned
tomatoes. During the summer of 2017, the joint costs of processing the tomatoes were
$2,086,000. The company maintains no inventories. Production and sales information
for the summer is as follows:
Product
Ketchup
Juice
Canned
Cases
100,000
175,000
200,000
Sales Value at Splitoff Point
$6 per case
8 per case
5 per case
Separable Costs
$3 per case
5 per case
3 per case
Selling Price
$24 per case
25 per case
10 per case
Determine the amount of joint cost allocated to each product if Red Stripe uses the estimated net realizable value method. What is the cost per case for each product?
joint-cost allocation for that product. The method can be broken down into three discrete
steps. Exhibit 16-7, Panel A, shows these steps for allocating the $400,000 joint costs between
buttercream and condensed milk in the Farmland Dairy example. Refer to the panel for an
illustration of each step as we describe it.
Step 1: Compute the Overall Gross-Margin Percentage. The overall gross-margin percentage for all joint products together is calculated first. This is based on the final sales value of total
production during the accounting period, not the total revenues of the period. Accordingly,
Exhibit 16-7, Panel A, uses $1,600,000, the final expected sales value of the entire output of buttercream and condensed milk, not the $1,290,000 in actual sales revenue for the month of May.
Step 2: Compute the Total Production Costs for Each Product. The gross margin (in dollars) for each product is computed by multiplying the overall gross-margin percentage by the
product’s final sales value of total production. The difference between the final sales value of
total production and the gross margin then yields the total production costs that the product
must bear.
Step 3: Compute the Allocated Joint Costs. As the final step, the separable costs for each
product are deducted from the total production costs that the product must bear to obtain the
joint-cost allocation for that product.