What are joint products what accounting issue results from the production process that creates joint products?

• 1 Joint and by-product costing
• 1.1 Definitions
• 1.1.1 Joint products
• 1.1.2 By-products
• 1.2 Treatment of joint costs
• 1.2.1 Accounting treatment for joint products
• 1.2.2 Accounting treatment for by-products

Joint and by-product costing

Joint and by-products are complications that can occur within the context of process costing.

Definitions

Joint products

Joint products are two or more products separated in the course of processing, each having a sufficiently high saleable value to merit recognition as a main product.

• Joint products include products produced as a result of the oil-refining process, for example, petrol and paraffin.
• Petrol and paraffin have similar sales values and are therefore equally important (joint) products.

By-products

By-products are outputs of some value produced incidentally in manufacturing something else (main products).

• By-products, such as sawdust and bark, are secondary products from the timber industry (where timber is the main or principal product from the process).
• Sawdust and bark have a relatively low sales value compared to the timber which is produced and are therefore classified as by-products

Treatment of joint costs

Accounting treatment for joint products

The distinction between joint and by-products is important because the accounting treatment of joint products and by-products differs.

• Joint process costs occur before the split-off point. They are sometimes called pre-separation costs or common costs.
• The joint costs need to be apportioned between the joint products at the split-off point to obtain the cost of each of the products in order to value closing inventory and cost of sales.
• The basis of apportionment of joint costs to products is usually one of the following:
  • sales value of production (also known as market value)
  • production units
  • net realisable value.

Accounting treatment for by-products

As by-products have an insignificant value the accounting treatment is different.

• The costs incurred in the process are shared between the joint products alone. The by-products do not pick up a share of the costs, like normal loss.
• The sales value of the by-product at the split-off point is treated as a reduction in costs instead of an income, again just the same as normal loss.
• If the by-product has no known value at the split-off point but does have a value after further processing, the net income of the by-product is used to reduce the costs of the process.

Net income (or net realisable value) = Final sales value - Further processing costs

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Tags:	process costing;joint products;by-products

A joint cost is a cost that benefits more than one product, while a by-product is a product that is a minor result of a production process and which has minor sales. Joint costing or by-product costing are used when a business has a production process from which final products are split off during a later stage of production. The point at which the business can determine the final product is called the split-off point. There may even be several split-off points; at each one, another product can be clearly identified, and is physically split away from the production process, possibly to be further refined into a finished product. If the company has incurred any manufacturing costs prior to the split-off point, it must designate a method for allocating these costs to the final products. If the entity incurs any costs after the split-off point, the costs are likely associated with a specific product, and so can be more readily assigned to them.

Besides the split-off point, there may also be one or more by-products. Given the immateriality of by-product revenues and costs, byproduct accounting tends to be a minor issue.

If a company incurs costs prior to a split-off point, it must allocate them to products, under the dictates of both generally accepted accounting principles and international financial reporting standards.  If you were not to allocate these costs to products, then you would have to treat them as period costs, and so would charge them to expense in the current period. This may be an incorrect treatment of the cost if the associated products are not sold until some time in the future, since you would be charging a portion of the product cost to expense before realizing the offsetting sale transaction.

Allocating joint costs does not help management, since the resulting information is based on essentially arbitrary allocations. Consequently, the best allocation method does not have to be especially accurate, but it should be easy to calculate, and be readily defensible if it is reviewed by an auditor.

How to Allocate Joint Costs

There are two common methods for allocating joint costs. One approach allocates costs based on the sales value of the resulting products, while the other is based on the estimated final gross margins of the resulting products. The calculation methods are as follows:

• Allocate based on sales value. Add up all production costs through the split-off point, then determine the sales value of all joint products as of the same split-off point, and then assign the costs based on the sales values. If there are any by-products, do not allocate any costs to them; instead, charge the proceeds from their sale against the cost of goods sold. This is the simpler of the two methods.

• Allocate based on gross margin. Add up the cost of all processing costs that each joint product incurs after the split-off point, and subtract this amount from the total revenue that each product will eventually earn. This approach requires additional cost accumulation work, but may be the only viable alternative if it is not possible to determine the sale price of each product as of the split-off point (as was the case with the preceding calculation method).

Price Formulation for Joint Products and By-Products

The costs allocated to joint products and by-products should have no bearing on the pricing of these products, since the costs have no relationship to the value of the items sold. Prior to the split-off point, all costs incurred are sunk costs, and as such have no bearing on any future decisions – such as the price of a product.

The situation is quite different for any costs incurred from the split-off point onward. Since these costs can be attributed to specific products, you should never set a product price to be at or below the total costs incurred after the split-off point. Otherwise, the company will lose money on every product sold.

If the floor for a product’s price is only the total costs incurred after the split-off point, this brings up the odd scenario of potentially charging prices that are lower than the total cost incurred (including the costs incurred before the split-off point). Clearly, charging such low prices is not a viable alternative over the long term, since a company will continually operate at a loss. This brings up two pricing alternatives:

• Short-term pricing. Over the short term, it may be necessary to allow extremely low product pricing, even near the total of costs incurred after the split-off point, if market prices do not allow pricing to be increased to a long-term sustainable level.

• Long-term pricing. Over the long term, a company must set prices to achieve revenue levels above its total cost of production, or risk bankruptcy.

In short, if a company is unable to set individual product prices sufficiently high to more than offset its production costs, and customers are unwilling to accept higher prices, then it should cancel production – irrespective of how costs are allocated to various joint products and by-products.

The key point to remember about the cost allocations associated with joint products and by-products is that the allocation is simply a formula – it has no bearing on the value of the product to which it assigns a cost. The only reason we use these allocations is to achieve valid cost of goods sold amounts and inventory valuations under the requirements of the various accounting standards.

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