Chapter 16, Cost Allocation

Starting August 2017, Sinclair Oil & Gas must report a separate product-line income statement for crude oil. One challenge facing Sinclair Oil & Gas is how to allocate the joint cost of producing the three separate salable outputs. Rate regulation when one or more of the jointly-produced products or services are subject to price regulation.

• For example a seller of a toothbrush not only offers the physical product but also the idea that the consumer will be improving the health of their teeth.
• The “with quantity structure” process uses the BOM and routing of the material as per the rules of costing variant to do cost calculations.
• Cost center whose costs are charged to other departments in the organization.
• Common costs are not the result of any manufacturing compulsion or the use of any single raw material.
• In accounting, a standard costing system is a tool for planning budgets, managing and controlling costs, and evaluating cost management performance.
• ‘Managers must decide whether a product should be sold at splitoff or processed further.
• The processing of a particular raw material may result into the output of two or more products.

A by-product or byproduct is a secondary product derived from a production process, manufacturing process or chemical reaction; it is not the primary product or service being produced. 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. Explain the effect that the different cost-allocation methods have on the decision to sell the products at splitoff or to process them further.

The issue is how to allocate joint costs—the $250,000 in production costs incurred prior to the split-off point—to the resulting joint products. One type of monetary measure of joint cost allocation is the sales value method. Using the sales value method, separate and differentiate the primary products according to sales value.

Understand the ways individual factors, social factors, and situational opportunities influence ethical behavior in a business setting. Throughput is the rate at which a company can produce and sell its goods to customers. Economies of scope describe situations where producing two or more goods together results in a lower marginal cost than producing them separately. This study concentrates to explore the area not so much conceptually, but more as a practical guide to illustrate some of the methods adopted in practice by the manufactures’. Company to valuate the inventory and for various internal and external reporting requirements. The selection of an allocation base in the direct method is easier than the selection of an allocation base in the step method. Need a deep-dive on the concept behind this application?

Why Is It Necessary To Apportion The Cost?

David has helped thousands of clients improve their accounting and financial systems, create budgets, and minimize their taxes. Product costing in SAP demands a detailed understanding of the business process and a strong integration with other modules. SAP provides elaborate process to map complex costing models. The key therefore is to understand the business process. In a similar fashion the cost of other intermediary by-products can be calculated as shown in the figure below. Process industry scenario with a possible costing model is discussed to exemplify the process.

Show the operating income for each product using the methods in requirement 1. Why might the number of products in a joint-cost situation differ from the number of outputs? Distinguish between a joint product and a byproduct.

• The latter refers to a reduction in marginal cost by producing additional units.
• If as a result of processing the product further, additional sales revenue exceeds additional costs, the wise decision is to process further.
• What is the danger in allocating common fixed costs among products or other segments of an organization?
• $\bullet$ The third chip is currently incorporated into a solid-state device under the AT name.
• Moreover, where the end products cannot be expressed in some common unit, this method breaks down.
• Literature survey has highlighted certain other methods as techno commercial factor evaluation basis and input based cost driver basis.

A physical base such as raw materials weight, linear measure volume etc. is applied in apportioning pre-separation point costs to joint products. For example, if there is 40% beef in product X and 60% beef in product Y, 4/10 of the cost up-to separation point will be charged to X and 6/10 to Y.

Which Joint Cost Allocation Method Is Best?

The final product or service cost will reflect the full cost only if these common costs are allocated or apportioned in some way to the individual final product. The co-products are further processed in respective processing plants to produce finished goods . The mother plant also produces some incidental/by-products (By-prod D, By-prod E) along with the coproducts. These by-products can be further processed in their respective processing units to produce finished goods, further by-products (By-prod D2) and Recyclable materials. Joint costs can be apportioned to different products only by means of some suitable bases of apportionment. Total costs of production of multiple products combine both joint costs and separable individual product costs.

• It will distort cost allocation due to fluctuations in market prices.
• In August $2017,$ Rich and Creamy Edibles Factory could have sold the chocolate-powder liquor base for $\$ 21$ a gallon and the milk-chocolate liquor base for $\$ 28$ a gallon.
• The cost of snakes is assigned to each product line using the relative sales value of meat, skins, and rattles (i.e., the percentage of total sales generated by each product).
• The accountant for SRC needs to record the information about the joint and byproducts in the general journal, but is not sure what the entries should be.
• Apply the sale proceeds to the firm’s miscellaneous income account.

Allocate joint costs to each product using the relative sales value method, and calculate the profit or loss for each product. Prior to the split-off point, production costs are allocated to jointly manufactured products. In Units basis, Common costs are apportioned between joint products on the basis ofthe total number of units produced. The cost per unit is the same for all the joint products.

What Method Is Most Commonly Used For Allocating Joint Processing Costs To Joint Products?

Could Chicago Oil have increased its November operating income by making different decisions about the further processing of products $A, B,$ or $D ? $ Show the effect on operating income of any changes you recommend.

The products did not require any further processing cost after split off point. The Rama Corporation produces four products in a manufacturing process. The Corporation produced 10,000 units of A, 20,000 units of B, 15,000 units of C and 25,000 units of D.

Elements Of Cost In Cost Accounting With Example

In such a case, the long-run average and marginal cost of a company, organization, or economy decreases due to the production of complementary goods and services. An unusable or unwanted substance or material produced during or as a result of a process, such as metabolism or manufacturing. B) “With quantity structure” calculations https://business-accounting.net/ feature of SAP is used to do the cost calculations. The “with quantity structure” process uses the BOM and routing of the material as per the rules of costing variant to do cost calculations. Joint product is also maintained as negative quantity in BOM of leading co-product to credit back its cost to the leading co-product.

Another example of joint costing is feeding both sheep and cattle. For example, dairy farmers separate raw milk from cows into whey and curds, with the curds going on to become cheese. Another example of this is the so-called black liquor produced when processing wood into paper pulp.

In some cases, such as the production of beef and hides from cattle, the outputs are obtained in relatively fixed proportions. However, even in case where the outputs emerges as solids, liquids and gases, a common unit or physical co-efficient such as weight, can normally be found as a conversion factor . Another form of physical unit basis is the weighted average method based on pre- determined standards. Some technical estimation is used to reduce all output to a moon denominator. The weights may possibly be based on size of units, time consumed in making them, material consumption etc. The actual numbers of output the Joint cost apportionment is based. In general, it is better to use a product’s market value at the split-off point than its estimated net realizable value in allocating joint costs.

Definition Of Joint Product

In deciding whether to outsource a service department or not, the cost of the service department should be estimated using the step method of allocation. One reason to allocate service department costs to user departments is to encourage the user departments to monitor their use of the service department costs. Show journal entries at the time of production and at the time of sale assuming SRC accounts for the byproduct using the sales method. The accountant for SRC needs to record the information about the joint and byproducts in the general journal, but is not sure what the entries should be. The company has hired you as a consultant to help its accountant. The Seattle Recycling Company purchases old water and soda bottles and recycles them to produce plastic covers for outdoor furniture.

It is logical to use this method as all products are produced out of the same materials and process of operations. The three stage calculation is used for equivalent units and cost allocation. Using the calculations of equivalent units and cost per equivalent units to obtain a cost for finished output and abnormal loss in period. Establishing the equivalent units of direct material and conversion costs for loss.

Apportionment Of Joint Costs With Illustrations

The costs of mixing, heating, and extracting the drug amount to $\$ 155,000$ per batch. The output sold for human use is pasteurized at a total cost of $\$ 130,000$ and is sold for $\$ 600$ per gallon. The product sold to veterinarians is irradiated at a cost of $\$ 20$ per gallon and is sold for $\$ 450$ per gallon.

Accounting Vs Bookkeeping

But the apportionment of joint costs involves many complexities and difficulties in cost accounting. The incurrence of common costs are joint products are outputs from common inputs and a common production process. influenced by management decisions, But joint costs are influenced by common production process and use of common raw materials.