Joint Product Costing

1 Introduction

Some processes cannot help producing more than one product. Refining crude oil yields petrol, diesel and bitumen together; crushing an oilseed yields oil and meal together; distilling a scent yields a strong concentrate and a weaker one. Up to the point where the outputs become separately identifiable there is one set of costs and no way of saying which part of it belongs to which product — because the products were not made separately.

The distinction between a joint product and a by-product is one of relative sales value, and it is a matter of judgement rather than of rule. It matters because the two are accounted for in completely different ways.

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2 Why a cost per unit is needed at all

There is no correct way to split a joint cost, because the products are made together: no part of the material can be traced to one output rather than another. Any apportionment is therefore arbitrary. It is still needed, for two of the four rationales for costing set out in chapter 1:

• inventory valuation — unsold output has to be carried at cost, and each joint product is a separate line of inventory;

• profit reporting — a cost of sales figure is needed for each product before a profit per product can be reported.

3 The accounting treatment

Two steps, in this order.

3.1 Step 1 — deal with the by-product

Because the by-product is not what the process exists to produce, its proceeds are deducted from the joint costs of the process, so that only the net cost is left to be shared between the joint products. Deducting the proceeds is equivalent to treating them as a negative cost; the by-product is never given a share of the joint cost, and no profit is reported on it.

The proceeds deducted are the proceeds of the by-product output for the period. Where the by-product needs work of its own before it can be sold, it is the net proceeds — sales value less the further costs — that are deducted.

An alternative treatment sometimes met is to credit by-product proceeds to sales revenue as other income. That leaves the joint cost unreduced and reports a different profit for each joint product, though the same profit overall. Unless a question directs otherwise, deduct the proceeds from the joint cost.

3.2 Step 2 — apportion the net joint cost

The remaining cost is shared between the joint products on one of three bases:

• physical units — the same cost per unit of output for every joint product (section 4);

• sales value at the split-off point, often called the market value basis (section 5);

• net realisable value, where there is no market at the split-off point (section 6).

The apportionment is always made on the units produced, never on the units sold. What has been sold affects the cost of sales and the closing inventory afterwards; it has nothing to do with sharing a cost that was incurred to produce everything that came out of the process.

4 Physical units basis

The net joint cost is divided by the total physical output of the joint products, giving one cost per unit that is applied to all of them.

Cost per unit = Joint cost less by-product proceeds ÷ Total units of joint product output

It is the simplest basis and it is defensible where the joint products are physically similar and are measured in the same units. It breaks down where they are not: there is no sensible way to add kilograms of one product to litres of another.

Its real weakness is what it does to reported profit, and example 1 is built to show it.

5 Sales value at the split-off point

Here the cost is shared in proportion to what each product is worth, so that a product with a high selling price is given a correspondingly high cost.

Joint cost apportioned = Net joint cost × (sales value of that product produced ÷ total sales value of production)

The sales value used is the value of what was produced, not of what was sold, and it is the value at the split-off point — the price the product could be sold for as it leaves the joint process.

6 Net realisable value basis

The market value basis needs a selling price at the split-off point, and often there is none: the products cannot be sold as they leave the process because each needs work of its own first. Bottling, refining, grading and packing are all examples.

In that case the net realisable value at the split-off point is used as a substitute for a market price:

Net realisable value = Final selling value − Further processing costs after the split-off point

The apportionment is then made exactly as in section 5, with net realisable value in place of sales value. It is not a third method so much as the second method with an imputed price.

7 Choosing a basis, and what an apportionment may be used for

None of the three is more correct than the others. They differ only in how they spread a cost that cannot be traced, and the choice changes each product’s reported profit without changing the total.

7.1 Why the apportionment must not drive a decision

The apportioned cost is incurred whichever decision is taken, so it is not relevant to any of them. The point is easiest to see on a decision to process a product further.

8 Test your knowledge

Two quick checks before you move on: work through the flashcards to fix this chapter’s key terms and definitions, then sit the objective questions for exam-style practice. Both mark themselves and explain the answers as you go.