Chapter 6, Joint cost allocation.doc

Chapter 6: Cost Allocation: Joint Products and

Byproducts

Terms

 Joint costs are the costs of a single production process that yields multiple products simultaneously.

 Separable costs are all costs of manufacturing, marketing, distribution, and so on. Incurred beyond the split off point those are assignable to one or more individual products.

 A joint product has relatively high sales value compared to other products yielded by a joint production process

 When a joint production process yields only one product with a relatively high sales value, the product is termed as main product.

 A byproduct has a relatively low sales value compared with the sales value of a joint or main product.

Approaches to Allocating Joint Costs

Approach 1: Allocate costs using market based data such as revenues.  Sales value at splitoff point

 Constant gross-margin percentage NRV method

Approach 2: Allocate costs using physical-measure-based data such as weight or volume. Example1: Farmers Dairy purchases raw milk from individual farms and processes it until the splitoff point, where 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.

 Raw milk processed 110,000 gallons. 10,000 gallons of raw milk are lost in the production process due to evaporation, spoilage, and the like, yielding 100,000 gallons of good product.

Cream 25,000 gallons 20,000 gallons at Br. 8/gallon Liquid skim 75,000 gallons 30,000 gallons at Br. 4/gallon

 Inventories

Beginning Inv Ending Inv

Raw milk 0 gallons 0 gallons

Cream 0 gallons 5,000 gallons

Liquid skim 0 gallons 45,000 gallons

 How much of the joint costs of Br.400,000 should be allocated to the cost of goods sold (20,000 gallons of cream and 30,000 gallons of liquid skim) and to the ending inventory (5,000 gallons of cream and 45,000 gallons of liquid skim)?

 Allocates joint costs to joint products on the basis of a relative sales value at the splitofff point of the total production of these products during the accounting period.

Cream Liquid Skim Total

1. Sales value at splitoff point (cream, Br.200,000 Br.300,000 Br.500,000 25,000 gall.*Br.8; liquid skim, 75,000

Gall.*Br.4)

2. Weighting (Br.200,000/Br.500,000; 0.40 0.60 Br.300, 000/Br.500, 000)

Br.400, 000; liquid skim, 0.60*Br.400, 000

4. Joint production cost per gallon (cream, Br. 6.40 Br.3.20 Br.160, 000/25,000 gall; liquid skim,

Br.240, 000/75,000 gall.)

Note that the method uses the sales value of the entire production of the accounting period. The reason is that the joint costs were incurred on all units produced, not just those sold in the current period.

 Allocates joint costs to joint products on the basis of the relative weight, volume, or other physical measure at the splitofff point of the total production of these products during the accounting period.

Cream Liquid Skim Total

1. Physical measure of production (gall.) 25,000 75,000 100, 000 2. Weighting (25,000gall/100,000 gall; 0.25 0.75

75,000gall/100,000gall)

3. Joint cost allocated (cream, 0.25* Br.100, 000 Br.300, 000 Br.400, 000 Br.400, 000; liquid skim, 0.75*Br.400, 000

Br.100, 000/25,000 gall; liquid skim, Br.300, 000/75,000 gall.)

3. Estimated Net Realizable Value (NRV) Method

 In many cases, products are processed beyond the splitoff in order to bring them to a marketable form or to increase their value above their selling price at the splitoff point.

Eample2: Assume the same situation as in Example 1 except that both cream and liquid skim can be processed further:

 Cream Butter cream; 25,000 gallons of cream are further processed to yield 20,000 gallons of butter cream at additional processing (separable) costs of Br.280, 000. Butter cream, sold for Br.25 per gallon, is used in the manufacture of butter-based products.

 Liquid skim Condensed Milk; 75,000 gallons of liquid skim are further

 Sales during the accounting period were 12,000 gallons of butter cream and 45,000 gallons of condensed milk.

Beginning Inventory Ending Inventory

Raw milk 0 gallons 0 gallons

Cream 0 gallons 0 gallons

Liquid skim 0 gallons 0 gallons

Butter cream 0 gallons 8000 gallons

The estimated NRV method allocates joint costs to joint products on the basis of the relative estimated NRV (expected final sales value in the ordinary course of business minus the expected separable costs) of the total production of these products during the accounting period. Joint costs would be allocated as follows:

Butter Condensed Total

Cream Milk

1. Expected final sales value of production

2. Deduct expected separable costs to

Complete and sell Br.280, 000 Br.520, 000 800,000 3. Estimated NRV at splitofff point Br.220, 000 Br.580, 000 Br. 800,000 75,000gall/100,000gall)

4. Weighting (220,000/800,000; 580,000/

800,000) 0.275 0.725

5. Joint costs allocated (butter cream, 0.275*

400,000; condensed milk, 0.725*400,000) Br.110, 000 Br.290, 000 Br.400, 000 6. Production cost per gallon (butter cream,

[110, 000+280,000]/20,000 gall; condensed

4. Constant Gross-Margin Percentage NRV Method

 Allocates joint costs to joint products in such a way that the overall gross margin percentage is identical for the individual products. This method requires three steps:

Step 1: Compute the overall gross-margin percentage.

Step 2: Use the overall gross margin percentage and deduct the gross margin from the final sales values to obtain the total costs that each product will bear

Step 3: Deduct the expected separable costs from the total costs to obtain the joint-cost allocation.

Expected final sales value of total production during the accounting period (20,000gall.*Br.25) + (50,000gall*Br.22) Br.1, 600,000 Deduct joint and separable costs (Br.400, 000+Br.280, 000+

Br.520, 000) 1,200,000

Gross Margin Br. 400,000

Step 2:

Butter Condensed Total

Cream Milk

During the accounting period: (butter Cream, 20000gall.*Br.25; condensed

Milk, 50,000gall*Br.22) Br.500, 000 Br.1, 100,000 Br.1, 600,000 Deduct gross margin, using overall

Gross margin percentage (25%) 125,000 275,000 400,000 Cost of Goods Sold 375,000 825,000 1,200,000

Step 3:

Deduct separable costs to complete and sell 280,000 520,000 800,000 Joint costs allocated Br.95, 000 Br.305, 000 Br.400, 000

 Joint production process may yield not only joint and main products but byproducts as well. Although byproducts have much lower sales value than do joint or main products, the presence of byproducts can affect the allocation of joint costs.

Example 3: The Meatworks Group processes meat from slaughterhouses. One of its departments cuts lamb shoulders and generates two products:

Shoulder meat (the main product) – sold for Br.60 per pack. Hock meat (the byproduct) - sold for Br.4 per pack.

Production Sales Big. Inv. End.Inv.

Shoulder meat 500 400 0 100

Hock Meat 100 30 0 70

The joint manufacturing costs of these products in July 2001 were Br.25, 000 (comprising, Br.15, 000 for direct materials and Br.10,000 for conversion costs). Method A: Byproducts Recognized at the Time Production is Completed

1. Work in process 15,000

Account Payable 15,000

(To record direct materials purchased and used in production during July)

2. Work-in Process 10,000

Various Accounts 10,000

(To record conversion costs in the production process during July; examples include energy, manuf.supplies, all Manu. labor, and plant maintenance)

3. Byproduct Inventory-Hock Meat (100*Br.4) 400 Finished Goods –Shoulder Meat (Br.25, 000-400) 24,600

(To record cost of goods completed during July)

4a. Cost of Goods Sold [(400/500)*24,600 19,680

Finished Goods-Shoulder Meat 19,680

(To record cost of the main products sold during July)

b. Cash (Account Receivable) 400*Br.60 24,000

(To record the sales of the main product during July)

5. Cash (Account Receivable) 30*Br.4 120

Byproduct Inventory- Hock Meat 120

(To record the sales of the byproduct during July)

This method reports the byproduct inventories of hock meat in the balance sheet at their Br.4/pack selling price [(100-30)*Br.4 = Br.280].

Method B: Byproducts Recognized at Time of Sale

In the Meatworks Group example, byproduct revenues in July 2001 would be Br.120 (30*Br.4) because only 30 packs of the hock meat are sold in

July (of the 100 packs produced). The journal entries would be: 1 and 2: Same as for Method A.

3. Finished Goods-Shoulder Meat 25,000

Work-in Process 25,000

(To record cost of goods completed during July)

4a. Cost of Goods Sold [(400/500)*Br.25, 000 20,000

4b. Same as for Method A

5. Cash (Account Receivable) 120

Revenues- Hock Meat 120

To record the sales of the byproduct during July)

Accounting for spoilage, defective units and scrap

Rework is unacceptable units of production that are subsequently repaired and sold as acceptable finished goods. For example, defective units of products such as computers detected during production or immediately after production but before units are shipped to customers can sometimes be reworked and sold as good products.

Scrap is material left over when making a product(s). It has low sales value compared with the sales value of the product(s).

2. Types of Spoilage

Normal Spoilage

Abnormal Spoilage

Abnormal Spoilage is spoilage that should not arise under efficient operating conditions. It is not an inherent result of the particular production process. Abnormal spoilage is regarded as avoidable and controllable. Line operators and other plant personnel can generally decrease abnormal spoilage by minimizing machine break downs, accidents and the like. Abnormal spoilage costs are written off as losses of the accounting period in which detection of the spoiled units occurs.

A key issue in accounting for spoilage in process-costing systems is how to count spoiled units. Units of abnormal spoilage should be counted and recorded separately. But what units of abnormal spoilage should be counted and recoded? Theses units can either be counted (Approach A) or not counted (Approach B).

Approach A leads to more accurate product costs because it makes visible the costs associated with normal spoilage and spreads it over good units.

production cycle. At the start of production, all direct materials required to make one output unit are bundled in a single kit. Conversion costs are added evenly during the cycle.

Some units of this product are spoiled as a result defects only detectable at inspection of finished units. Normally spoiled units are 10% of the goods output. Summary of data for July 2004 are:

Work in Process, beginning inventory (July 1) 1,500 units Direct Materials (100% complete)

Conversion costs (60% complete)

Started during July 8,500 units

Completed and transferred out during July 7,000 good units Work in Process, ending inventory (July 31) 2,000 units

Direct Materials (100% complete) Conversion costs (50% complete) Total Costs for July 2004

Direct materials (1,500 equivalent units * Br. 8) Br. 12,000

Conversion costs (900 equivalent units * Br.10) 9,000 Br. 21,000 Direct materials costs added during July 76,500

Conversion costs added during July 89,100

Total costs to account for Br.186, 600

Step 1: Summarize the Flow of Physical Units of Output. Identify units of both normal and abnormal spoilage.

= (1,500+8,500) – (7,000 + 2,000) = 1,000 units

Normal Spoilage is 10% of the 7,000 units of good output, or 700 units. Thus, Abnormal Spoilage = Total Spoilage – Normal Spoilage

= 1,000-700

= 300units

Step 3: Compute Equivalent unit costs.

Step 4: summarize Total Costs to Account for.

Step 5: Assign Total Costs to units completed, to spoiled units, and to units in ending work-in process.

Physical units and Equivalent units (Step 1&2)

Flow of Production Physical

Units DirectMaterials Conversioncosts Work in process, beginning

Started during current period To account for

Goods units completed and transferred out during current period:

300*100%; 300*100% Work in process, ending 2,000*100%; 2,000*50% Accounted for

Work done in current period

2,000 10,000 2,000 10,000 1,000 9,000 Calculation of Product Costs (Steps 3, 4, and 5)

Total Production Costs

Direct

Materials Conversioncosts

Costs added during the current period Costs incurred to date divided by Equivalent units of work done to date Cost per equivalent unit of work done (Step 4) Total costs to account for

(Step 5) Assignment of Costs

Goods units completed and transferred out (7,000 units)

Costs before adding normal spoilage Normal Spoilage (700 units)

Total cost of goods completed and transferred out

Abnormal Spoilage(300 units)

Work in process, ending (2,000 units) Direct Materials

Conversion costs

Total work in process Total costs accounted for

B. FIFO Method

Equivalent Units

Flow of Production Physical

Units

Direct Materials

Conversion costs Work in process, beginning

Started during current period To account for

Good units completed and transferred out during current period

From beginning work in process

1,500*(100%-100%); 1,500*(100%-60%)

Started and Completed

Abnormal Spoilage 300*100%; 300*100% Work in process, ending 2,000*100%; 2,000*50% Accounted for

Work done in current period

8,500 8,100

Costs (Step 3) Work in process, beginning

Costs added current period

Divided by equivalent units of work done in current period

Costs per equivalent unit of work done in the current period

(Step 4) Total costs to account for (Step 5) Assignment of Costs

Good units completed and transferred out

(7,000 units)

Work in process, beginning (1,500 units) Direct Materials added in current period Conversion costs added in current period Total from beginning inventory before spoilage

Started and completed BNS(5,500units) Normal Spoilage (700 units)

Total costs of goods units transferred out Abnormal Spoilage (300 units)

Work in process, ending (2000 units) Direct Materials

Conversion costs

Total work in process, ending Total costs accounted for

18,000 11,000 29,000 Br.186,600 2000*9 1,000*11 Journal Entries

Weighted Average FIFO

Work-in Process-Forming 152,075 151,600 (To transfer good units completed in July)

Loss from Abnormal Spoilage 5,925 6,000

Work-in Process-Forming 5,925 6,000

(To recognize abnormal spoilage detected in July)

The above illustration assumes inspection upon completion. Spoilage might actually occur at various stages of the production cycle, but it typically detected only at one or more specific inspection points.

An inspection point is the stage of the production cycle where products are checked to determine whether they are acceptable or unacceptable units. The cost of spoiled units is assumed to be all costs incurred by spoiled units prior to inspection. When spoiled units have a disposal value, the net cost spoilage is computed by deducting disposal value from the costs of the spoiled goods accumulated to the inspection point

The concepts of normal and abnormal spoilage also apply to job-costing systems. Abnormal spoilage is usually regarded as controllable by the manager. Costs of abnormal spoilage are not considered as inventor able costs and are written off as costs of the period in which detection occurs.

Example: In a Machine Shop 5 aircraft parts out of a job lot of 50 aircrafts parts are spoiled. Costs assigned prior to inspection point are $2,000 per part. The current disposal price of the spoiled parts is estimated to be $600 per part. When the spoilage is detected, the spoiled goods are inventoried at $600 per part.

Materials Control (5*$600) 30001

Work-in Process Control (specific job) (5*$600) 3000

Normal Spoilage common to all jobs: In some cases, spoilage may be considered a normal characteristics of a given production cycle. The spoilage inherent in production only coincidently occurs when a specific job is being worked on. The spoilage is not then attributable, and hence is not charged, to the specific job. Instead it is considered as manufacturing overhead. The journal entry is:

Materials Control (spoiled goods at disposal value 5*$600) 3000

MOH Control (normal spoilage $10,000-$3,000) 7000

Work-in Process Control (specific job 5*$2,000) 10000

When normal spoilage is common to all jobs, the budgeted MOH rate includes a provision for normal spoilage cost. Therefore, normal spoilage cost is spread, through overhead

allocation, over all jobs rather than loaded on particular jobs only. The total cost of the 45 good units is $90,000 (45 units*$2,000 per unit) plus a prorated share of the $7,000 of normal spoilage overhead costs.

Abnormal Spoilage: if the spoilage is abnormal, the net loss highlighted and always charged to an abnormal loss account. Unlike normal spoilage costs, abnormal spoilage costs are not included as apart of the cost of goods unit produced. The total cost of the 45 good units is $90,000 (45 units*$2,000 per unit).

Materials Control (spoiled goods at current disposal value: 3000

Work-in Process Control (specific job) 10000

5. Rework

Rework is unacceptable units of production that are subsequently repaired and sold as acceptable finished goods.

Example: Consider Hull Machine Shop; assume that the 5 spoiled parts used in the illustration are reworked. The journal entry for the $10,000 of total cost assigned to the 5 spoiled units before considering rework costs are as follows:

Materials Control 4000

Wage payable Control 4000

MOH Allocated 2000

MOH Control (rework costs) 3800

Materials Control 800

Wage payable control 2000

MOH Allocated 1000

Abnormal rework: if the work is abnormal, it is recorded by charging abnormal rework to a separate loss account.

Loss from Abnormal Rework 3800

Wage Payable Control 2000

MOH Allocated 1000

Accounting for rework in a process costing system also requires abnormal rework to be distinguished from normal rework. A process costing system accounts for abnormal rework in the same way as a job-costing system. Accounting for normal rework follows the accounting described for normal rework common to all jobs because masses of identical or similar units are manufactured in process costing systems.

Scrap is a material left over when making a product(s); it has low sales value compared with the sales value of the product(s). There are no distinctions of normal and abnormal scrap, but scrap attributable to a specific job is distinguished from scrap common to all jobs.

There are two major aspects of accounting for scrap:

1. Planning and control, including physical tracking.

 When should the value of scrap be recognized in the accounting records at the time scrap is produced or at the time scrap is sold?

 How should revenue from scrap be accounted for?

To illustrate: In Hull co. assuming that the manufacturer of aircraft parts generates scrap. We further assume that the scrap from a job has a total sales value $900.

the storeroom and to regard scrap sales as a separate line item of other revenues. The only journal entry is:

Cash or A/R 900

Sales of Scrap 900

(Sale of Scrap)

For scrap returned to storeroom: No journal entry2

Sale of Scrap: Cash or A/R 900

Work-in Process Control 900

Unlike spoilage and rework, there is no cost attached to the scrap, and hence no distinction is made between normal and abnormal scrap. All scarp sales, whatever the amount, are credited to the specific job. Scrap sales reduce the costs of the job.

Sale of scrap: Cash or A/R 900

MOH Control 900

This method does not link scrap with any particular job or product. Instead, all products bear regular production costs without any credit for scrap sales except in an indirect manner. The expected sales are considered when setting he budgeted MOH rate. Thus, the budgeted OH rate is lower than it would be if the OH budget had not been reduced by the expected sales of scrap. This accounting for scrap is both in process costing and job costing systems.

6.2. Recognizing Scrap at the Time of its Production

In the preceding illustration the assumption is that scrap returned to the storeroom is sold quickly and hence not assigned an inventory cost figure. Sometimes however, the value of scrap is not immaterial, and the time between storing it and selling or reusing it can be quite long.

Under conditions, the company is justified in inventory scrap at a conservative estimate conditions of net realizable value so that production costs and related scrap recovery are recognized in the same accounting period. Some companies tend to delay sales of scrap until the market price is most attractive.

Scrap returned to storeroom: Materials Control 900

Work-in Process Control 900

 Scrap common to all jobs: The journal entry in this case is

Scrap returned to storeroom: Materials Control 900

MOH Control 900

Sale of Scrap: Cash or A/R 900

Materials Control 900

Scrap returned to storeroom: Materials Control 900

MOH Control 900

Reuse of Scrap: Work-in Process Control 900

Materials Control 900