Joint products are the products or items that use the same production process and input at the same time. Since they use the same process, it is impossible to differentiate costs until they reach a point when they need a separate production process. Thus, before their split-off end, one can only allocate the costs to the joint products.
It is impossible to separately identify the costs of these items before a ‘split-off point’ or ‘separation point.’ There can be two or more joint products. A few examples of such products are using crude oil to get gasoline, diesel, lubricants, and other products; and using milk to get butter, cheese, and cream.
Some joint products need a separate production process after the split-off point to convert them into the finished good. There could be joint products that are saleable when they arrive at the split-off point, but they may still need some processing to add more value. In such a case, it is the responsibility of the management to examine whether or not they benefit from the additional work will be more than the costs of the other expenses.
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Characteristics of Joint Products
Following are the characteristics of joint products:
- The value of all the joint products is more or less the same.
- Such products don’t necessarily require processing after a point of separation. It means that a company can usually sell them after they pass the split-off point.
- Such products need simultaneous standard processing.
- The raw material or materials they use are the same.
As said above, it is impossible to separate costs for these products until after the separation point. Thus, we need to allocate costs. There are several methods that we can use to allocate costs up to the split-off point. These are:
Physical Units Method
Under this method, we use a physical base, such as raw materials, weight, or volume, to allocate costs. We allocate the costs based on the output weight of the joint products. For example, we get 1,000 lbs of coke and 500 lbs of gas per tonne of coal. The overhead cost per tonne of fuel is $1,000.
Coke represents 67% (1000/1500), while gas presents 33% (500/1500) of the total. Now, allocating cost on this percentage. So, the overhead cost for coke is $670 and for gas $330.
This method is simple to use, understand, and implement. Moreover, it is technically logical, as well. However, we won’t be able to use this method if the output is in different types of units.
Market Value Method
Under this method, we allocate joint costs based on the selling price of each joint product. The logic behind such an allocation is that a product with a high selling price must get a more substantial proportion of the cost.
To allocate the cost, we can either use the market value at the time of the split-off point or their final selling price. Some also use net realizable value to allocate costs. The net realizable value is the final selling price, less direct selling and distribution expenses, and the production expenses after the separation point.
Contribution Margin Method
In this method, we first divide the joint costs into fixed and variable costs. Then, we allocate the variable costs to the products based on the number of units or any other physical quantity. If any product incurs variable expenses after the separation point, then we should add this variable cost to the variable cost allocated earlier.
Now, deduct the total variable cost of each product from its respective sale value to get the contribution for the product. We can now efficiently allocate the fixed cost using the contribution ratio of each product.
Let us understand this method with the help of an example. Company ABC makes three products A, B, and C in the following quantities 50 units, 30 units, and 20 units. The total cost is $10,000, including $6,000 as fixed costs. The selling price of A, B, and C is $100, $120, and $140.
Joint variable cost will be $10,000 Less $6,000 = $4,000 and total production will be 100 units (50+30+20). Now, variable cost per unit will be $40 ($4000/100).
Contribution for product A= 50*($100 Less $40) = $3,000; Contribution for product B = 30*($120 Less $40) = $2,400; Contribution for product C will be 20* ($140 Less $40) = $2,000.
Total Contribution = $3,000 + $2,400 + $2,000 = $7,400.
Now allocating fixed cost on the basis of contribution. For product A = $6000 * ($3000/$7400) = $2432, for product B will be $6000 * ($2400/$7400) = $1946, for product C will be $6000 * ($2000/$7400) = $1622.
Average Unit Cost Method
In this, we divide the total joint costs up to the separation point by the total units that the company produces. It gives the average cost per unit of production. Using this method makes sense when the processes for the products are the same and inseparable. And also when we can express the output in a standard unit.
For example, Company ABC produces 10,000 units (A= 3,000, B= 5,000, and C=2,000 units). Total joint cost is $20,0000. The average cost per unit in this case is $20 ($200000/10000). Now the cost for product A is $20*3,000 = $60,000, B is $20*5000 = $100,000, and for C is $20*2000 = $40,000.
This measure assumes that the cost difference between the joint products is because of some qualitative and quantitative factors. These factors could be difficulties in manufacturing, time for production, use of raw materials, and more. Thus, we assign weights (or points) to each product after carrying a technical survey. These points serve as the basis to allocate joint costs.
For instance, there are two products A and B. After the survey, the points given to both are 2 and 4. If joint costs are $600, then the cost for A will be $200 ($600 * 2/6), while for B, it will be $400 ($600 * 4/6).
Standard Cost Method
A company can use this method only if it is using the standard costing system. In this, we set the standard costs for every joint product. After this, we allocate joint costs among the products using the standard costs. This method is beneficial for ascertaining the efficiency of the production process. Also, it helps to compare the actual costs with the standard ones, and thus assist in determining the final price.
Direct Allocation Method
Companies use this method if it is possible to trace or estimate the joint costs to each of the joint products.
By-products, Co-products, and Scrap
In cost accounting, not all products that use a single process are joint products. Instead, the products that have significant economic value qualify as a joint product. The products that don’t have any significant commercial amount or the company doesn’t intend to manufacture it are the by-products.
In case the by-product has no saleable value or no economic value, then we call it as spoilage or scrap. Usually, managers don’t assign any costs to by-products.
Co-products are those that may use the production facilities but require different raw materials and maybe processed as well. For example, tables, chairs, and desks are co-products. A company can produce co-products in varying quantities without changing the production of other co-products. On the other hand, in joint products, it is impossible to change the amount of one without adjusting the output of others.1–4