Week 2

Week 2

1. Reasons for allocating joint costs

2. Approaches to allocating joint costs

   • Physical measures
     • 1. Physical measures – allocate using tangible attributes of the products, such as kilograms, litres, barrels, etc.
   • Market-based measures
     • 2. Market-Based measures – allocate using market-derived data (dollars): a) Sales value at splitoff b) Net realisable value (NRV) c) Constant gross-margin percentage NRV
     • a) Sales value at split-off method
       • Allocates the costs of joint products produced during the accounting period on the basis of the relative total sales at the split-off point. This method uses the sales value of the entire production of the accounting period, not just the quantity sold, because the joint costs were incurred on all units produced, not just the portion sold during the current period. Costs are allocated to products in proportion to their revenue-generating power (expected revenue).
     • b) Physical-measure method
       • Allocates joint costs to joint products producing on the basis of a comparable physical measure (weight, quantity, volume at the split-off point). Because the physical-measure allocates joint costs on the basis of weight (e.g. kg or gallons), the cost per kg is the same for all joint products. This method is less desirable than sales value at split-off method because because the physical measure of individual products may have no relationship to their revenue-generating abilities (e.g. 10 kg of gold is worth more than 100kg of coal). This method excludes byproducts because of their low sales value compared to joint/main products.
     • c) Net realizable value
       • Allocates joint costs to joint products produced on the basis of their NRV. NRV = final sales value - separable costs. NRV is used to the sales value at split-off point only when the selling price for one or more products at split-off point does not exists (zero sales value) therefore, further processing would be needed in order for products to become valuable (positive sales value).
     • c) Constant gross-margin percentage NRV
       • Allocates the joint costs to joint products produced in a way that each individual product achieves the same gross-margin percentage. This method works backwards in that the overall gross margin is calculated first. Then the gross-margin percentage, and any separable costs, are deducted from the final sales value. This method can be broken into 3 steps: Step 1: Compute the overall gross margin percentage Step 2: Compute the total production costs for each product Step 3: Compute the allocated joint costs
       • This method is the only one whereby products receive negative allocations. profitable and unprofitable products are averaged out. This also takes into account profits earned before and after the split-off point when allocating the joint costs.
       • Step 1: Compute the overall gross margin percentage
         • This is based on the final sales value of total production, not the total sales revenue received for the period.
       • Step 2: Compute the total production costs for each product
         • Convert gross-margin to dollars by multiplying the overall gross-margin percentage by the products final sales value of total products. The difference is the total production costs that the product must bear.
       • Step 3: Compute the allocated joint costs
         • Separable costs, for each product,  are deducted from the total production costs that the product must bear to obtain joint-cost allocation for that product.

3. Choosing an Allocation Method

   • If selling price at splitoff is available, use the sales value at splitoff method. If selling price at splitoff is not available, use the NRV method. If simplicity is the primary consideration, physical measures method or the constant gross-margin method could be used. This is if end prices are volatile or the process after split-off is long or uncertain, this method wold be favoured.
   • Not allocating joint costs
     • Some companies choose not to allocate joint costs to products due to the complexity of their production or extraction processes and the difficulty of gathering a sufficient amount of data to allocate the costs correctly. Rather than allocating joint costs, some firms subtract costs directly from the total revenues earned.

4. Sell-or-Process-Further Decisions

   • If wanting to further process joint products, the decision to incur additional costs for further processing should be based in the incremental operating income attainable beyond the split-off point. Joint costs incurred before the split-off point are irrelevant in deciding whether to further process because these are inevitable costs in order to sell the product and to reach the split-ff point. What matters is the incremental income for additional processing (is more beneficial to sell immediately or process further and sell later?)
   • Incremental costs
     • Incremental costs are additional costs incurred for an activity, such as further processing. Not all separable costs are incremental costs, some separable costs may be: - fixed costs - sunk costs - allocated costs etc.

5. Accounting for byproducts