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Chapter 9 Joint Product and By-Product Costing LEARNING OBJECTIVES Chapter 9 addresses the following questions: LO1 LO2 LO3 LO4 LO5 LO6 LO7
Describe a joint process, and explain the difference between a by-product and a main product. Allocate joint costs. Explain the factors that are considered in choosing a joint cost allocation method. Identify the relevant information for deciding whether to process a joint product beyond the split-off point. Apply the methods that are used to account for the sale of by-products. Explain how a sales mix affects joint cost allocations. Evaluate the uses and limitations of joint cost information.
These learning questions (LO1 through LO7) are cross-referenced in the textbook to individual exercises and problems.
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QUESTIONS 9.1
Some goods are produced jointly; many products result from a common process. These are called joint products. Main products have high sales value relative to other products when split-off occurs. By-products have low sales value relative to the main products’ values.
9.2
Because all of the other products are sold at $200 or more, the product that sells for only $10 would probably be considered a by-product. Main products have relatively high sales values compared to by-products.
9.3
There are two methods of recognizing revenue from by-products. The revenue can be recognized at the split-off point, or recognized at the time of sale. The treatment depends on whether the NRV is positive or negative, and also on whether it is recognized at the time of production or sale. Negative NRV is always added to joint costs. When positive NRV is recognized at time of production, it is subtracted from joint costs. When positive NRV is recognized at time of sale, it may be treated as revenue, treated as non-revenue income, or subtracted from COGS.
9.4
Products from any of the following industries would be appropriate: oil and gas, chemical, lumber products, tour companies, meat production, wheat production, milling companies.
9.5
Joint costs are product costs that cannot be separately traced to individual products, so they are indirect with respect to individual products. Separable costs are the direct costs of producing separate products (but these costs may or may not be direct with respect to individual units).
9.6
The split-off point in a joint process occurs at the point when the individual joint products become separately identifiable. All costs incurred up to the split-off point are joint costs and (assuming no further split-off points) the costs that follow are separable costs identifiable with a specific joint product.
9.7
Here are a few examples; students may think of others that are also appropriate. A professor may do some consulting work that simultaneously generates ideas for a journal article (main product), a case for a book (main product), and a problem for an exam (byproduct). A CA firm may work on client development that simultaneously produces prospective engagements for the auditing and tax services (all probably main products). A research scientist may have an individual project that results in twenty-two patentable items (some may be main products, some may be by-products, and some may be scrapped).
9.8
Once the joint product emerges, the joint cost should be viewed as a "sunk" cost; it is a past cost that should not influence subsequent product decisions. Further processing decisions should be made based on the additional revenues obtained in relation to the additional separable costs needed to obtain those revenues.
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9.9
If all joint products were sold in the period produced, costs might not need to be allocated. But for financial reporting, all production costs must be assigned to cost of goods sold and ending inventories of the joint products to match revenues and expenses.
9.10
The contribution of each product is the selling price less separable costs. Revenues and separable costs are relatively easy to identify and measure. Therefore accountants know each product’s contribution. However, if profit is defined to mean accounting income, all costs including fixed and joint costs are allocated. To allocate costs, an allocation base must be chosen. Different allocation bases result in different profit figures. Hence, the profitability of one joint product cannot be uniquely determined, but will vary with different allocation bases.
9.11
Because the products have relatively equal value, they should all be treated as main products.
9.12
To perform market based joint cost allocations (net realizable value and constant gross margin NRV), an estimate is made of the sales value of each product. Common and separable costs are known with reasonable certainty, but price may be estimated. If the market for goods is not volatile, the price can be determined from past experience. If prices change frequently, information sources such as competitor’s prices or a list of commodity prices could be used for estimates.
9.13
Following are qualitative factors that might influence managers to process a joint product beyond the split-off point. The organization may offer a product mix, and dropping one of the products could affect sales of other products, so a group of products are always processed further. An example of this would be meat related products. Even though round steak does not need to be processed further, some people want very lean hamburger and customers may shop elsewhere if lean hamburger is not sold. Manager preferences might affect the decision to process further. For example, managers of a dairy might have a preference for a particular type of cheese that other dairies do not produce, and so they continue producing it even though sales are low and the milk could be used for other products. Resource scarcity encourages managers to consider new processes for raw materials such as sawdust and wood chips. Environmental issues also influence joint product decisions. Sometimes companies choose to convert waste into a by-product that can be sold to avoid contributing to waste disposal. Another factor is the effect on employees and local communities. Managers may choose to continue additional processing even when the financial results are relatively weak to avoid closing production facilities and laying off employees.
9.14
Some by-products are valuable and could be stolen, and so internal controls and records are kept. For by-products that are unlikely to be stolen, no controls or records need to be kept. An example of a by-product that could be stolen is raw malachite, a by-product of copper production that can be further processed into cabochons for jewellery. An example of a by-product that would not need controls is whey from dairy product processing.
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Cost Management Some managers may be responsible for the success of certain main products. If the profit varies widely depending on the joint cost method used, managers of products with relatively large allocations of cost will feel that the system is unfair. It is possible that some products would even appear to be unprofitable under a particular joint cost allocation method, and managers would then be penalized unfairly. When allocated joint costs affect managers’ performance evaluations, then the “fairness” of the allocation becomes their concern.
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MULTIPLE-CHOICE QUESTIONS 9.16
SMT Ltd. manufactures three products. Production begins with a joint process, and the three outputs of the joint process are processed further to produce products L, M, and N. The outputs at split-off have no market value. Last year, the joint costs amounted to $600,000. Other data for last year are as follows: Selling price per unit Costs per unit after split-off point to complete and sell Total output at split-off point used in production Production in units Sales in units
Product L $160 $100 16,400 kg 20,000 18,000
Product M $300 $200 10,000 kg 10,000 8,000
Product N $400 $350 8,400 kg 7,000 7,000
Using the estimated (approximate) net realizable value method of joint costing, the inventory cost per unit of product M is: a) $226.91 b) $223.53 c) $221.52 d) $220.00 e) $217.24 Ans: B [L: ($160-$100) * 20,000 = $1,200,000 NRV; M: ($300-$200)*10,000 = $1,000,000 NRV; N: ($400-$350) * 7,000 = $350,000 NRV; Total NRV = $1,200,000+$1,000,000+$350,000 = $2,550,000; M: $1,000,000/$2,550,000 * $6,000,000 = $235,294 allocated joint costs M: ($235,294/10,000 ) + $200 = $223.57 total unit costs. The following information pertains to Questions 9.17 and 9.18: Omega Company manufactures three chemicals in a joint process. The manufacturing costsof the joint process include $25,000 of direct materials and $35,000 of conversion costs. All threechemicals can be sold in their unrefined form immediately after the splitoff point, or they canbe further refined before they are sold. During May, all three chemicals were further refined. Thefollowing table shows data regarding production for the month of May: Chemical A B C Sales price per litre before refining $ 20 $ 25 $ 10 Sales price per litre after refining $ 35 $ 40 $ 18 Cost of refining $28,000 $10,000 $12,000 Total output of chemical at split-off 2,500 L 1,600 L 3,000 L Total output of chemical after refining 2,300 L 1,500 L 2,700 L
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Cost Management Using the sales value at split-off method, the total joint cost allocated to Chemical A in May(rounded to the nearest hundred dollars) is: a) $21,100 b) $25,000 c) $22,600 d) $25,500 e) $33,600 Ans: B ($20*2,500)/[($20*2,500)+($25*1,600)+($10*3,000)] * ($25,000+$35,000) = $25,000
9.18
Now assume that Omega Company uses the physical measures method, that the refining processfor Chemical C also produces a hazardous by-product that must be disposed of at a cost of $5 perlitre, and that refining 1,000 L of Chemical C results in 100 L of this byproduct. For the monthof May, what effect would refining Chemical C have on Omega Company's profits as comparedwith its profits if Chemical C was sold at split-off without being further refined (rounded to thenearest $100)? a) $17,100 more profits by refining b) $20,300 less profits by refining c) $8,100 more profits by refining d) $5,100 more profits by refining e) $8,400 less profits by refining Ans: D ($18*2,700)-12,000-(300*$5) = $35,100; $35,100-($10*3,000) =$5,100 The following information pertains to Questions 9.19 and 9.20: Omega Company manufactures three chemicals in a joint process. The manufacturing costsof the joint process include $25,000 of direct materials and $35,000 of conversion costs. Allthree chemicals are then processed further before they are sold. Other pertinent data are asfollows: Chemicals A B C
9.19
Sales Value at Split-off $50,000 40,000 30,000
Separable Costs $28,000 10,000 12,000
Final Sales Value $100,000 60,000 40,000
Using the estimated net realizable value method, the joint costs allocated to ChemicalA would be: a) $16,800 b) $25,000 c) $28,800 d) $30,000 e) $33,600 Ans: C in thousands ($100-$28)/[($100-$28)+($60-$10) + ($40-$12)]*($25+$35)=$28.8
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The decision to process all three chemicals beyond the split-off point is suboptimal. If the optimaldecision had been made, the income of Omega Company would have improved by: a) $2,000 b) $10,000 c) $30,000 d) $60,000 e) $12,000 Ans: A (Only C should not be processed passed split-off. Selling C at split-off will increase revenue by $2,000).
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EXERCISES 9.21
Identifying Joint Products
A. The following are joint products 1. Sand produced with three levels of fineness. The sand is produced by processing raw dirt and includes a number of joint costs such as labour and equipment. Some of the products are processed further. 3. Milk products are joint products because they all come from one liquid that is processed further, depending on the product. 6. Airlines could be considered as incurring joint costs because a large proportion of cost is common to all of the products. The following are not joint products 2. Automobiles and trucks because either one can be manufactured without producing the other. 4. Motorcycles and mopeds because either one can be manufactured without producing the other. 5. Clothing can be manufactured in any style without producing other styles and is therefore not a joint product. B. Two other product groups would include tour services or cruise lines, products manufactured from crude oil such as gasoline, diesel, and heating oil, and many types of food products such as beverage manufacture, cereals, milling operations, and so on. 9.22
Identifying Joint and Separable Costs - Cowboy Cattle Company 1. Joint 2. Separable 3. 4. 5. 6.
Joint Joint Separable Separable
7. Joint
All cattle require veterinary work, and the cost per specific cow is incurred before the split-off point. The cost occurs after the split-off point and can be traced directly to hamburger. The cost is incurred before the split-off point. The cost is incurred before the split-off point. The cost is incurred after the split-off point, specifically for leather. The cost is incurred after the split-off point, specifically for steaks and roasts. Cost of production incurred before the split-off point.
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Profitability of Joint Products – Larry Dean
A. The total joint cost is $700, which represents the costs incurred before puppies were born. The rest of the costs are separable. First calculate the NRV by type of puppy and in total: 2 Chocolate Males [2 puppies × ($300 – $160 – $40)] $ 200 2 Yellow Males: [2 puppies × ($400 – $160)] 480 2 Yellow Females: [2 puppies × ($450 – $160)] 580 Total NRV $1,260 Then use each product’s relative proportion of NRV to allocate the joint cost: 2 Chocolate Males [($200/$1,260) × $700] 2 Yellow Males [($480/$1,260) × $700] 2 Yellow Females [$580/$1,260 × $700] Total allocated
$111.11 266.67 322.22 $700.00
B. Gross profit on sale of each puppy: Chocolate Male [$300 – $160 – $40 – ($111.11)/2)] Yellow Male [$400 – $160 – ($266.67/2)] Yellow Female [$450 – $160 – ($322.22/2)] 9.24
$ 44.44 per puppy 106.67 per puppy 128.89 per puppy
By-Product Further Processing Decision According to the following calculations, the contribution margin is higher if the byproduct is sold at the split-off point rather than processed further. Therefore, the byproduct should not be processed further. Sold at split-off: 100 x $8 = $800 Processed further: 100 x ($19 - $12) = $700
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9.25
NRV Method, Contribution Margin, Further Processing for a Service - Deluxe Tours
A. Number of passengers Revenue Incremental costs Net realizable value Allocated lease cost Margin
First-Class 100
Tourist-Class 200
$200,000 30,000 170,000 100,000 a $ 70,000
$200,000 30,000 170,000 100,000 b $ 70,000
a $200,000 lease cost * [$170,000/($170,000+$170,000] = $100,000 b $200,000 lease cost * [$170,000/($170,000+$170,000] = $100,000 B. The answer to this question depends upon what is meant by “the contribution margin generated by first-class passengers.” An accountant could determine it is $70,000, the margin after deducting a share of the lease cost. However, a more accurate reflection would be $170 per passenger, the revenue generated by first-class passengers, less the incremental costs of serving those passengers. An alternative answer is to consider the amount of margin generated by having a separate class of passengers rather than filling the entire cruise ship with tourist-class passengers. Assume that 25 tourist-class berths replaced 20 first-class berths. (Students could make any reasonable assumption concerning how many tourist-class berths would replace firstclass berths.) So, the trade-off is 25 tourist-class versus 20 first-class berths. Incremental contribution margin if first-class cabins are sold to tourist-class passengers: Contribution per passenger for first-class: $200 - $30 = $170 Contribution per passenger for tourist-class: $100 - $15 = $85 Contribution for 20 first class passengers (20 x $170) Contribution for 25 tourist class passengers (25 x $85) Additional contribution for first class
$3,400 2,125 $1,275
C. In the example above, no allocated costs were considered because they are essentially sunk costs for the decision to use the space for first-class or tourist class. Those costs are incurred either way, so only incremental contribution is analyzed.
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Four Joint Cost Allocation Methods with Sales Mix, Further Processing Decision The Palm Oil Company
A. Computation of $100,000 joint-cost allocation using four allocation methods: (1) Sales value at split-off point Sales Value at Product Split-Off Point Soap grade $ 50,000 Cooking grade 30,000 Light moisturizer 50,000 Heavy moisturizer 70,000 $200,000
Proportions 50/200 = 0.25 30/200 = 0.15 50/200 = 0.25 70/200 = 0.35
Allocation of $100,000 $ 25,000 15,000 25,000 35,000 $100,000
Proportion 100/500 = 0.20 300/500 = 0.60 50/500 = 0.10 50/500 = 0.10
Allocation of $100,000 $ 20,000 60,000 10,000 10,000 $100,000
(2) Physical volume Soap grade Cooking grade Light moisturizer Heavy moisturizer
Physical volume 100,000 litres 300,000 litres 50,000 litres 50,000litres 500,000litres
(3) Estimated Net Realizable Value Product Fine Soap Superior Cooking Oil Light moisturizer Premium Moisturizer
Estimated Final Sales Separable Value Costs $300,000 $200,000 100,000 80,000 50,000 0 120,000 90,000
Net Realizable Value $100,000 20,000 50,000 30,000 $200,000
Allocation Proportion of $100,000 100/200=0.50 $ 50,000 20/200=0.10 10,000 50/200=0.25 25,000 30/200=0.15 15,000 $100,000
(4) Constant Gross Margin Method First calculate the gross profit margin ratio for all products: Product Final Sales Value Fine Soap $300,000 Superior Cooking Oil 100,000 Light Moisturizer 50,000 Premium Moisturizer 120,000 Total $570,000 Less joint costs Gross margin
Separable Costs $200,000 80,000 0 90,000 $370,000
Gross profit margin ratio = $100,000/$570,000 = 0.175439 © 2012 John Wiley and Sons Canada, Ltd.
Contribution $100,000 20,000 50,000 30,000 200,000 100,000 $100,000
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Second, apply the gross profit margin ratio to each product to determine cost of goods sold. Then subtract separable costs from cost of goods sold to determine the joint cost allocation for each product. Product Fine Soap Superior Cooking Oil Light Moisturizer Premium Moisturizer
Revenue $300,000 100,000 50,000 120,000 $570,000
Gross Margin* $ 52,632 17,544 8,772 21,052 $100,000
Separable Allocation Costs of $100,000 $200,000 $ 47,368 80,000 2,456 0 41,228 90,000 8,948 $100,000
COGS 247,368 82,456 41,228 98,948
* Gross margin = Revenue x Gross profit margin ratio = Revenue x 0.175439 B. Contribution from Processing Soap Grade into Fine Soap: Incremental revenue = $300,000 - 50,000 Incremental costs Incremental operating income
$250,000 200,000 $ 50,000
Contribution from Processing Cooking grade oil into Superior Cooking Oil: Incremental revenue = $100,000 - 30,000 $ 70,000 Incremental costs 80,000 Incremental operating income $(10,000) Contribution from Processing Heavy Moisturizer into Premium Moisturizer: Incremental revenue = $120,000 - 70,000 $ 50,000 Incremental costs 90,000 Incremental operating income $(40,000) Operating income can be increased by $50,000 if both Cooking Grade Oil and Heavy Moisturizers are sold at the split-off point. Soap Grade should continue to be processed further. 9.27
Sales Value at Split-Off, Physical Output, NRV Methods,Further Processing Decision - Flowering Friends
A. 1. Sales value at split-off point method Premium Regular
Sales Value at Split-off Point ($5*2,000) $10,000 ($3*8,000) 24,000 $34,000
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Percent 29% 71 100%
Allocation of $15,000 $ 4,350 10,650 $15,000
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2. Physical output method Number of Pots 2,000 8,000 10,000
Percent 20% 80 100%
Allocation of $15,000 $ 3,000 12,000 $15,000
Net Realizable Value ($25*2,000) $ 50,000 ($10*8,000) 80,000 $130,000
Percent 38% 62 100%
Allocation of $15,000 $ 5,700 9,300 $15,000
Premium Regular 3. Net realizable value method Premium Regular
B. Based on a comparison of the contributions for each alternative, the company should process further: Sell as premium Process further ($35 – $20/4 - $3) Extra contribution from processing further 9.28
$25 27 $ 2
NRV and Physical Output Methods, Further Processing Decision - Click and Clack Recyclers
A. There are no separable costs for these products, so each product’s net realizable value is the revenue per litre. However, one litre of oil yields 0.7 motor oil and 0.3 fuel oil, so for each litre of oil produced, the total NRV is 0.7*$3 + 0.3*$1.50 = $2.55. The total costs per litre are $0.75 + $1.25 = $2.00. The inventory cost per litre of residual fuel oil is ($1.50*0.3)/$2.55*$2.00 = $0.3529 B. If allocated cost were based on physical output, the cost per litre for residual fuel oil is 0.3*$2.00 = $0.60. C. Special fuel would need to match the contribution for residual fuel oil. The contribution for residual fuel oil is $1.50 per litre. The minimum acceptable price for Special Fuel Oil is $1.50 plus the $0.40 per litre for additional processes or $1.90 per litre. At this price the managers would be indifferent to selling residual oil or processing it further.
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9.29
By-product Value Recognized at Time of Production Versus Time of Sale - Mile High Lumber Mill
A. Income Statement with By-Product Value Recognized at the Time of Sale Revenue: Lumber (270,000 BF x $3) Scraps (900 logs x $10) Total Revenue Cost of Goods Sold (270,000BF x $2a) Gross Margin a
$810,000 9,000 819,000 540,000 $279,000
Cost is calculated as follows: $600,000/300,000 bd ft = $2 per BF
B. Income Statement with By-Product Value Recognized at the Time of Production Value of inventory for the main product: Joint product costs incurred Less NRV of by-product (1,000 logs x $10) Net joint product cost
$600,000 10,000 $590,000
Product cost per board foot ($590,000/300,000 bd ft)
$1.966667
Income statement: Revenue (270,000 BF x $3.00) Cost of Goods Sold (270,000 BF x $1.966667) Gross Margin
$810,000 531,000 $279,000
Notice that there is no difference between gross margins under the two methods. This will be true only under rigid conditions: (1) the proportion of main products sold is equal to the proportion of by-products sold during the period, and (2) there is either no beginning inventory or by-products in beginning inventory are sold for the exact amount estimated during the prior period. However, as long as by-product values are immaterial, the methods have little effect on the income statement and balance sheet. 9.30
Physical Output, NRV, and Constant Gross Margin NRV Methods,Further Processing Decision - The Paint Palette Company
A. Physical output method: For Premium: (30% * $10,000) For regular: (70% * $10,000) Total allocated © 2012 John Wiley and Sons Canada, Ltd.
$ 3,000 7,000 $10,000
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B. NRV method For premium [30%*4,000 litres * ($5 - $1)] For regular [70%*4,000 litres * ($2.5 – $.25)] Total NRV
$ 4,800 6,300 $11,100
Allocation: Allocated to premium ($4,800/$11,100)*$10,000 Allocated to regular ($6,300/$11,100)*$10,000 Total allocated costs
$ 4,324 5,676 $10,000
C. Constant Gross Margin NRV Method First, determine gross margin percentage: Total revenue (30%*4,000*$5)+ (70%*4,000*$2.5) Less: Separable costs ($1*4,000*30%) + ($.25*4,000*70%) $ 1,900 Common costs 10,000 Gross margin Gross margin percentage ($1,100/$13,000)
$13,000 11,900 $ 1,100 8.46153%
Next, allocate common cost: Revenue Gross Margin Separable costs Allocated Common Cost
Premium $6,000 (508) (1,200) $4,292
Regular $7,000 (592) (700) $5,708
D. Compare the contribution per litre of the two alternatives: Contribution per litre if processed further ($22 - $11 - $1) Continue with current process: ($10 - $.25x4) Increase in contribution per litre if process further
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$10 9 $ 1
Total $13,000 (1,100) (1,900) $10,000
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9.31
Calculate Missing Information for Sales Value at Split-off Point Method - The Chile Salsa Company This problem can be solved in a series of steps, where the answers for some parts are needed to answer others. If joint costs are allocated based on the sales value at split-off point method, the joint costs for Spicy Hot are: ($25,000/$100,000) * $60,000 = $15,000 (1) Therefore, the joint cost for Medium is ($60,000 - $24,000 - $15,000) = $21,000 (2) Now the values for sales at split-off for medium and mild can be calculated: Medium: [($21,000/$60,000)*$100,000] = $35,000 (3) Mild: ($100,000 - $35,000 - $25,000) = $40,000 (4)
Units produced Joint costs Sales value at split-off point Additional cost if process further Sales value if processed further
Mild 24,000 $24,000 (4) $40,000 $9,000 $55,000
Medium ? (2)$21,000 (3) $35,000 $7,000 $45,000
Spicy Hot ? (1)$15,000 $25,000 $5,000 $30,000
Total 48,000 $60,000 $100,000 $21,000 $130,000
Notice that the information about units produced was irrelevant in this problem. 9.32
Further Processing Profit and Decision - Conrad Miller
A. Allocation for Very Flexible under the sales value at split-off point method: $120,000/($1,500,000) * $900,000 = $72,000 Gross profit: Revenue – Separable costs – Allocated joint costs = $135,000 - $12,000 - $72,000 = $51,000 B. Based on a comparison of the contribution of the two alternatives, the company should process further: Sell at split-off Process further ($135,000 - $12,000) Contribution from processing further © 2012 John Wiley and Sons Canada, Ltd.
$120,000 123,000 $ 3,000
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Accounting for Main Products and By-products - Nutri-Smoothie
A. Gross margin if by-product value is recognized at time of production Value of inventory for main product Joint product costs incurred $12,000 Less NRV of by-product (2,000) Net joint product cost $10,000 Income statement Revenue (18,000 * $2.00) $36,000 Joint costs ($10,000/20,000 *18,000) (9,000) Gross margin $27,000 B. Gross margin if by-product value is recognized at the time of sale Revenues: Smoothies (18,000 * $2.00) $36,000 Revenues: Compost 2,000 Total revenue 38,000 Joint Costs ($12,000/20,000)*18,000 (10,800) Gross Margin $27,200 C. Inventories if by-product value is recognized at the time of production: Smoothies ($10,000/20,000 *2,000) $1,000 Compost ($2,000/8,000 * 2,000) 500 Ending Inventories if by-product value is recognized at the time of sale: Smoothies ($12,000/20,000 *2,000) $1,200 Compost 0
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PROBLEMS 9.34
Identifying Joint Costs, Choice of Allocation Method - Roses to Go
A. Roses to Go must pay someone to water and tend to the roses. The company must pay for labour to cut the roses. It pays for fertilizer and water and depreciation on any buildings used in the production and cutting process. If the roses are cooled after cutting, the cost of cooling must be paid. All of these are joint costs. B. Use the physical volume method because it is the most simple and will not distort costs if there is little difference in the packaging and pricing of the products. C. If there are different prices, the sales value at split-off point method would work best here because the separable costs would be very similar. This method is most simple and would be the best choice because it does not distort the costs. 9.35
NRV, Processing Further Decision – Deepa Company
A. First calculate the NRV for Products 1 and 2: Product 1 ($4 × 10,000 kg) Product 2 [($3 – $2) × 30,000 kg] Total NRV
$40,000 30,000 $70,000
Notice that the joint costs ($55,000 + $65,000 = $120,000) are greater than the total NRV, and so the products are unprofitable. Next, allocate joint costs based on NRV: Product 1 [($40,000/$70,000) × $120,000)] Product 2 [($30,000/$70,000) × $120,000)] Total Allocated
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$ 68,571 51,429 $120,000
Chapter 9: Joint Product and By-Product Costing Finally, calculate the gross profit for pounds sold by product line and total: Product 1 Sales Revenue: Product 1 (7,000 kgs× $4 per kg) Product 2 (26,000 kgs× $3 per kg) Separable Costs: Product 2 (26,000 kgs× $2 per kg) Joint Costs: Product 1 [(7,000/10,000) × $68,571] Product 2 [(26,000/30,000) × $51,429] Gross Margin (Loss)
Product 2
$ 28,000 $ 78,000 0 48,000 _______ ($20,000)
52,000
44,572 ($18,572)
B. Under the new assumptions the calculation of gross profit is as follows: First calculate the NRV for Products 1 and 2: Product 1 ($5× 10,000 kg)-$20,000 Product 2 [($3 – $2) × 30,000 kgs] Total NRV
$30,000 30,000 $60,000
Notice that the joint costs ($55,000 + $65,000 = $120,000) are greater than the total NRV, and so the products are unprofitable. Next, allocate joint costs based on NRV: Product 1 [($30,000/$60,000) × $120,000)] Product 2 [($30,000/$60,000) × $120,000)] Total Allocated
$ 60,000 60,000 $120,000 Product 1
Sales Revenue: Product 1 (10,000 kg× $5 per kg) Product 2 (30,000 kg× $3 per kg) Separable Costs: Product 1 ($20,000 per 10,000 kg) Product 2 (30,000 kg× $2 per kg) Joint Costs (per 10,000 kgand 30,000 kg) Gross Margin (Loss)
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Product 2
$ 50,000 $ 90,000 20,000 60,000 ($30,000)
60,000 60,000 ($30,000)
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Cost Management C. Compare the contribution when Product1 is sold “as is” and when it is processed further: When sold “as is” ($4 per kg × 10,000 kg) When processed further [($5 per kg× 10,000 kg) – $20,000]
$40,000 $30,000
Based solely on quantitative factors, Product 1 should be sold “as is” after its joint production with Product 2. 9.36
NRV – Ali Chemical Company
A. The joint costs are incurred prior to either product’s individual processing: The cost to purchase the mixture The cost to process the mixture into the products Total Joint Costs
$5,000 1,500 $6,500
B. The separable costs for each product are calculated as follows: SLX-241 ($2 per litre× 400 litres)
$800
QY-58 ($0.50 per kg × 200 kg of inert substance)
$100
C. Determine the NRV of each product: SLX-241 [($8 per litre× 400 litres) – $800] QY-58 [($6 per kg × 1,000 kg) – $100] Total NRV
$2,400 5,900 $8,300
Note: The total volume of QY-58 is equal to the original volume at the split-off point of 800 kg plus the additional inert substance of 200 kg, or a total of 1,000 kg. Based on the relative NRV values, the joint costs are allocated as follows: SLX-241 [($2,400/$8,300) × $6,500] QY-58 [($5,900/$8,300) × $6,500] Total Allocation
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$1,880 4,620 $6,500
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The cost per unit of each product is then calculated as follows: Joint Costs Separable Costs (from Part A) Total Costs per Product
SLX-241 $1,880 800 $2,680
Number of units produced Cost per Unit 9.37
QY-58 $4,620 100 $4,720
400 litres
1,000 kg
$6.70 per litre
$4.72 per kg
Separable and Joint Costs, NRV, Operating Income, By-product - Doe Corporation The following chart traces the physical flow of the products and summarizes cost and sales information.
Slicing Crushing Juicing Animal Feed Total
Weight After Total Weight Evaporation Loss 94,500 kg (35%*270,000) 75,600 kg (28%*270,000) 72,900 kg 67,500 kg (27%*270,000) (72,900/1.08) 27,000 kg (10%*270,000) 270,000 kg
Costs $ 4,700 10,580 3,250 700 $19,230
Total Revenue $ 56,700 ($0.60*94,500) 41,580 ($0.55*75,600) 20,250 ($0.30*67,500) 2,700 ($0.10*27,000) $121,230
A. The total weights are obtained by multiplying the initial 270,000 kilograms by the proportion of product by weight transferred to departments given. See table above. B. Product Slices Crushed Juice Total
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Selling price $ 56,700 41,580 20,250 $118,530
Separable cost $ 4,700 10,580 3,250 $18,530
NRV $ 52,000 31,000 17,000 $100,000
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Cost Management C. None of the costs are assigned to the by-product. The allocation of the $60,000 of cutting department costs to the main products is reduced by $2,000 ($2,700 - $700) for the NRV of animal feed (the by-product), so $58,000 is allocated Product Slices Crushed Juice Total
NRV $ 52,000 31,000 17,000 $100,000
Proportion 52% 31% 17%
Allocation $30,160 17,980 9,860 $58,000
D. Sales Joint cost Separable cost Gross margin
Slices $56,700 30,160 4,700 $21,840
Crushed $41,580 17,980 10,580 $13,020
Juice $20,250 9,860 3,250 $ 7,140
Total $118,530 58,000 18,530 $ 42,000
E. The gross margin information is of little value to management. As long as the overall processing is profitable, the net realizable value approach will show each of the products as valuable. For product mix decisions (such as whether to produce more juice and less crushed pineapple), information is needed about incremental revenues and costs rather than gross margin data. F. If there is no disposal revenue, the additional costs are $800 to dispose of the outside skin plus $2,700 in lost revenue (assuming that $700 of chopping costs would not be increased). The $3,500 would be added to each product in the same proportions as in part C. Thus the correct additional costs would be: Slices Crushed Juice Total
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Additional Cost $1,820 1,085 595 $3,500
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Cumulative Problem (Chapter 4): Optimal Product Mix, Joint Cost Allocation Using Three Methods – Aromasoaps
[Note: This problem requires application of knowledge from Chapter 4.] A sample spreadsheet using Excel Solver for this problem is available on the Instructor’s web site for the textbook (available at www.wiley.com/canada/eldenburg). Below are manual calculations. A. Incremental profit from further processing: Relaxation Energizer Harmony
Incremental Revenue* Incremental Cost [$15,000 – (3,000 × $2)] = $9,000 $ 8,000 [$72,000 – (12,000 × $4)] = $24,000 20,000 [$73,000 – (33,000 × $2)] = $7,000 10,000
Net $ 1,000 4,000 (3,000)
* Incremental revenue is calculated as the difference between total revenue after processing and total revenue at the split-off point for each product. Relaxation and Energizer should be processed beyond the split-off point. Further processing of Harmony yields an incremental loss of $3,000, so it should not be processed further. B. Profit from the optimal sales mix: Relaxation $15,000 8,000
Sales Processing Joint Cost Income
Energizer $72,000 20,000
Harmony $66,000 0
C. Joint cost allocation under the physical volume method: Relaxation Energizer Harmony Total
Number of Units 3,000 12,000 33,000 48,000
Proportion 3,000/48,000 12,000/48,000 33,000/48,000
Allocation $ 5,625 22,500 61,875 $90,000
D. First calculate NRV, assuming the optimal sales mix: Relaxation ($15,000 – $8,000) Energizer ($72,000 - $20,000) Harmony (sold at split-off point) Total NRV © 2012 John Wiley and Sons Canada, Ltd.
$
7,000 52,000 66,000 $125,000
Total $153,000 28,000 90,000 $ 35,000
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Cost Management Then use the NRV calculations to allocate joint costs: Relaxation [($7,000/$125,000) × $90,000] Energizer [($52,000/$125,000) × $90,000] Harmony [($66,000/$125,000) × $90,000] Total Allocation
$ 5,040 37,440 47,520 $90,000
E. Joint cost allocation using final sales value of $153,000 (from part B): Relaxation [($15,000/$153,000) × $90,000] Energizer [($72,000/$153,000) × $90,000] Harmony [($66,000/$153,000) × $90,000] Total Allocation
$
8,823 42,353 38,824 $90,000
It is inappropriate to use final sales value to allocate joint costs because it ignores the additional costs incurred to earn the additional revenues. F. This part requires recalculation of the apparent optimal sales mix according to gross margins calculated using the joint cost allocations from Parts C, D, and E. PHYSICAL OUTPUT METHOD Gross Margins if Sold at the Split-Off Point: Relaxation Energizer Harmony
Revenue $ 6,000 (3,000 × $2) 48,000 (12,000 × $4) 66,000 (33,000 × $2)
Gross Margins if Processed Further: Separable Revenue Cost Relaxation $15,000 $ 8,000 Energizer 72,000 20,000 Harmony 73,000 10,000
Joint Cost Allocation $ 5,625 22,500 61,875
Gross Margin $ 375 25,500 4,125
Joint Cost Allocation $ 5,625 22,500 61,875
Gross Margin $ 1,375 29,500 1,125
Under the physical output method, Relaxation and Energizer would be processed further, but not Harmony. This is same as the optimal sales mix (Part B). However, this result will not always hold. With a different set of values, the apparent optimal sales mix using gross margins could be different than the actual optimal sales mix.
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NRV METHOD Note: The calculations shown below assume that the joint cost allocations from Part D would not be affected by changes in the managers’ decisions to process a product further. Gross Margins if Sold at the Split-Off Point: Relaxation Energizer Harmony
Revenue $ 6,000 48,000 66,000
Gross Margins if Processed Further: Separable Revenue Cost Relaxation $15,000 $ 8,000 Energizer 72,000 20,000 Harmony 73,000 10,000
Joint Cost Allocation $ 5,040 37,440 47,520
Gross Margin $ 960 10,560 18,480
Joint Cost Allocation $ 5,040 37,440 47,520
Gross Margin $ 1,960 14,560 15,480
Under the NRV method, Relaxation and Energizer would be processed further, but not Harmony. This is same as the optimal sales mix (Part B). FINAL SALES VALUE METHOD Note: The calculations shown below assume that the joint cost allocations from Part E would not be affected by changes in the managers’ decisions to process a product further. Gross Margins if Sold at the Split-Off Point: Relaxation Energizer Harmony
Revenue $ 6,000 48,000 66,000
Gross Margins if Processed Further: Separable Revenue Cost Relaxation $15,000 $ 8,000 Energizer 72,000 20,000 Harmony 73,000 10,000
Joint Cost Allocation $ 8,823 42,353 38,824
Gross Margin $ (2,823) 5,647 27,176
Joint Cost Allocation $ 8,823 42,353 38,824
Gross Margin $ (1,823) 9,647 24,176
Under the final sales value method, Relaxation and Energizer would be processed further, but not Harmony. This is same as the optimal sales mix (Part B). However, this result will not always hold. With a different set of values, the © 2012 John Wiley and Sons Canada, Ltd.
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Cost Management apparent optimal sales mix using gross final sales values could be different than the actual optimal sales mix.
9.39
Physical Output Method, Drop a Product, Special Order - Jumping Juice Ltd.
A. According to the requirements of the problem, the costs of the vat process need to be allocated, which would amount to $30,000 [=$5,000 + $250*100]. Allocation base: Volume Relative volume
Standard Grade 20,000 bottles 2/3
Allocated cost of vat process: Standard (2/3*$30,000) Premium (1/3*$30,000)
Premium Grade 10,000 bottles 1/3
$20,000 $10,000
Cost of handling and bottling: Standard ($1,000+$100*200 barrels) Premium ($2,000+$200*100 barrels)
21,000 ______
22,000
Total cost
$41,000
$32,000
20,000 bottles
10,000 bottles
Divided by volume Cost per bottle
$2.05
$3.20
B. Allocation base: Volume Relative volume Allocated variable joint cost: Standard (2/3*$250*100) Premium (1/3*$250*100)
Standard Grade 20,000 bottles 2/3
Premium Grade 10,000 bottles 1/3
$16,667 $8,333
Variable cost of handling and bottling: Standard ($100*200) Premium ($200*100)
20,000 ______
20,000
Total variable cost
$36,667
$28,333
Divided by volume
20,000 bottles
10,000 bottles
Variable cost per bottle
© 2012 John Wiley and Sons Canada, Ltd.
$1.83
$2.83
Chapter 9: Joint Product and By-Product Costing C.
As Is Production: Standard Grade Premium Grade Revenue As Is ($3*20,000+$5*10,000) All Premium Grade ($5*30,000)
20,000 bottles 10,000 bottles
All Premium Grade 30,000 bottles
$110,000 $150,000
Joint Costs As Is ($5,000+$250*100) All Premium Grade (same)
(30,000) (30,000)
Handling and bottling: Standard grade: As Is ($1,000+$100*200) Discontinue Standard
(21,000) (0)
Premium grade: As Is ($2,000+$200*100) All Premium Grade ($2,000 + $200 * 300) Profit (Loss)
160
(22,000) (62,000) $ 37,000
$ 58,000
Profit would increase from $37,000 to $58,000 if all raw cider was treated as premium grade. . D. If a special order of premium cider were produced without producing any standard cider, the decision to produce premium would require incurring the fixed and variable vat costs, as well as the fixed and variable costs for premium bottling. The special order would need to pay for all of these costs. 9.40
Identify Joint Costs in Complex Process, Income Statement, By-Product, Opportunity Cost – Goodman and Sons
A. Joint costs of producing Product A and Product B is the sum of Department 1 and Department 2 costs: $10,000 + $10,000 = $20,000 Note: If the by-product (produced in department 3) had a negative NRV, then the negative NRV would also be included in the joint costs. However, department 3 generates positive incremental cash flows, so the by-product NRV will be recognized according to the company’s policy (at time of sale). B. Allocation of joint costs using the NRV method: © 2012 John Wiley and Sons Canada, Ltd.
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Product A Product B Total
Separable Revenue Costs NRV $40,000 $25,000 $15,000 6,000 5,000 1,000 $16,000
Joint Cost Proportion Allocation $15,000/$16,000 $18,750 $1,000/$16,000 1,250 $20,000
C. Income Statement using the NRV method and assuming that all products are sold (i.e., no beginning or ending inventories): Revenue ($40,000 + $6,000) Cost of goods sold: Joint costs Separable costs ($25,000 + $5,000) By-product NRV ($10,000 – $2,000) Gross Margin
$46,000 $20,000 30,000 (8,000)
42,000 $ 4,000
Note: The by-product NRV of $8,000 could be subtracted from cost of goods sold (as shown above). Alternatively, it could have been included in revenues or listed below gross margin as other income. D. Because no market exists for intermediate products, the opportunity cost of Product B for purposes of determining whether it should be processed further is its net realizable value of $1,000. 9.41
Joint Product, By Products, Weighted-Average Process Costing - S-T Inc. Physical Flow WIP beginning Started Completed and transferred out Ending WIP
2 batches (30% and 80% converted) 21 batches 20 batches 1 batch (50% converted)
Equivalent units and costs under weighted average. Remember that under weighted average, beginning inventory is counted as part of units completed. Also remember that direct material and conversion costs from work completed on beginning inventory and costs incurred this period are summed. Following are the equivalent units and costs under weighted average.
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Equivalent Units (Batches) Work performed this period: Materials Conv. Costs Units completed 20.0 20.0 Ending inventory (50% complete) 1.0 0.5 Total 21.0 20.5 Costs to account for: Beginning WIP Current costs Total
Materials $ 8,550 71,250 $79,800
Conv. Costs $ 3,007 40,740 $43,747
Cost per equivalent unit
$3,800
$2,134
Total $ 11,557 111,990 $123,547 $5,934
Process Cost Report – Weighted Average Method Units completed ($5,934 x 20) Ending inventory Materials ($3,800 x 1.0) Conversion ($2,134 x 0.5) Total ending WIP Total costs accounted for
$118,680 $3,800 1,067 4,867 $123,547
By-product Z is valued at its estimated selling price of $1 per litre. This amount is subtracted from the cost of batches completed to arrive at the net amount of joint costs to be allocated: Cost of goods completed (calculated above) Less by-product sales (20 batches x 100 L x $1) Net joint cost
$118,680 (2,000) $116,680
Note that the firm produced 400 L x 20 batches = 8,000 litres of X and 500 L x 20 batches = 10,000 litres of Y. Given these volumes, the joint costs are allocated to each product as follows under the net realizable value method Litres Price per litre Separable costs per litre
Product X 8,000 $8 $2
Product Y 10,000 $11 $3
Sales revenue Separable costs NRV
$64,000 16,000 $48,000
$110,000 30,000 $ 80,000
Total
$174,000 46,000 $128,000
The final step is to calculate the total costs assigned to each product and then calculate the total cost per litre:
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Cost Management Product X Allocation of joint costs: X: $116,680 x ($48/$128) Y: $116,680 x ($80/$128) Separable costs Total Cost
Product Y
$43,755 16,000 $59,755
$ 72,925 30,000 $102,925
Divided by litres
8,000
10,000
Total Cost per litre
$7.47
$10.29
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MINI-CASES
9.42
Profit at Split-off Point and After Further Processing, Manager Incentives and Decisions - Champion Chip Company First translate amounts to Canadian dollars and total. Deluxe Superior Sales value at split-off point If process further: Sales value Separable costs
Good
Total
400£*2 = $800
3,200 HK$*0.125 = $400
Cdn$200
CAD$1,400
550£*2=$1,100 200£*2 = $400
4,800 HK$*0.125=$600 800 HK$*0.125=$100
Cdn$800 Cdn$500
CAD$2,500 CAD$1,000
Good $200
Total $1,400 1,000
143 $ 57
______ $ 400
A. Sales Joint costs: Deluxe ($800/$1,400)*$1,000 Superior ($400/$1,400)*$1,000 Good ($200/$1,400)*$1,000 Pre-tax income
Deluxe $800
Superior $400
571 286 $229
$114
B. Below is the proforma income statement if only the Deluxe chip is processed further. The Deluxe manager will choose to sell at split-off point (income of $229 versus $53) Sales Separable costs Net realizable value Joint costs: Deluxe ($1,100/$1,700)*$1,000 Superior ($400/$1,700)*$1,000 Good ($200/$1,700)*$1,000 Pre-tax income
© 2012 John Wiley and Sons Canada, Ltd.
Deluxe $1,100 400 700
Superior $400 0 400
Good $200 0 200
Total $1,700 400 1,300 1,000
118 $ 82
______ $ 300
647 235 $ 53
$165
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Cost Management Below is the proforma income statement if only the Superior chip is processed further. The Superior manager will choose to process further (income of $125 versus $114) Sales Separable costs Net realizable value Joint costs: Deluxe ($800/$1,600)*$1,000 Superior ($600/$1,600)*$1,000 Good ($200/$1,600)*$1,000 Pre-tax income
Deluxe $800 0 800
Superior $600 100 500
Good $200 0 200
Total $1,600 100 1,500 1,000
125 $ 75
______ $ 500
500 375 $300
$125
Below is the proforma income statement if only the Good chip is processed further. The Good manager will choose to sell at the split-off point (income of $57 versus a loss of $100). Sales Separable costs Net realizable value Joint costs: Deluxe ($800/$2,000)*$1,000 Superior ($400/$2,000)*$1,000 Good ($800/$2,000)*$1,000 Pre-tax income
Deluxe $800 0 800
Superior $400 0 400
Good $800 500 300
Total $2,000 500 1,500 1,000
400 $(100)
______ $ 500
400 200 $400
$200
C. The best decisions for the firm are for each division to bring in the highest contribution. For Deluxe, selling at the split-off point is best ($800 at split-off point versus $700 if processed further). For Superior, process further ($500 for processing further versus $400 for selling at split-off). For Good, process further ($300 for further processing versus $200 at split-off point). D. Below is the proforma income statement if all managers make best decision for their division: Sales Separable costs Net realizable value Joint costs: Deluxe ($800/$1,600)*$1,000 Superior ($600/$1,600)*$1,000 Good ($200/$1,600)*$1,000 Pre-tax income © 2012 John Wiley and Sons Canada, Ltd.
Deluxe $800 0 800
Superior $600 100 500
Good $200 0 200
Total $1,600 100 1,500 1,000
125 $ 75
______ $ 500
500 375 $300
$125
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Below is the proforma income statement if all managers make the optimal decision for overall profitability Sales Separable costs Net realizable value Joint costs: Deluxe ($800/$2,200)*$1,000 Superior ($600/$2,200)*$1,000 Good ($800/$2,200)*$1,000 Pre-tax income
Deluxe $800 0 800
Superior $600 100 500
Good $800 500 300
Total $2,200 600 1,600 1,000
363 $ (63)
______ $ 600
364 273 $436
$227
Notice that the choice of an accounting procedure encourages the managers to act in their own interest instead of the interest of the firm as a whole. E. Note that if the net realizable value method is used to allocate the joint cost, the managers will reach the following stable solution. The allocation of joint costs would be
Deluxe Superior Good
Eventual Selling Separable Price Costs $800 $ 0 600 100 800 500
Net Realizable Value $ 800 500 300 $1,600
Allocation 8/16(1000) $ 500.00 5/16(1000) 312.50 3/16(1000) 187.50 $1,000.00
Given this allocation, the income statement would be: Sales Joint Further processing Pre-tax Income
Deluxe $800 500 $300
Superior $600 312 100 $188
Good $800 188 500 $112
Total $2,200 1,000 600 $ 600
F. Managers often act in the best interest of their divisions. If allocations are used to determine the income of divisions, the allocations may distort the profitability of each division, relative to the entire company. G. Bonuses should be based on a combination of factors, both financial and non-financial, and on the profitability of both divisions and the entire corporation. This type of incentive structure encourages managers to maximize efforts that lead to best overall profitability for the entire corporation.
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9.43
NRV Method, Division Manager Incentives, Qualitative Factors - Hudziak Industries
A. Allocation of joint costs: Ingredient J-52A Quitoban Total
Sales Value $1,500 1,400
Separable Cost $150 250
Net Realizable Value $1,350 1,150 $2,500
Proportion Allocation $1,350/$2,500 $1,080 $1,150/$2,500 920 $2,000
Sales: J-52A $5/L * 300L = $1,500; Quitoban $7/kg * 200kg = $1,400 Income per lot: Sales Joint cost Separable cost Income Per Lot
Chemicals $1,500 1,080 150 $ 270
Cosmetics $1,400 920 250 $ 230
Total $2,900 2,000 400 $ 500
B. The allocation of the cost of the new material would be: Net Sales Separable Realizable Ingredient Value Cost Value J-52A $1,500 $400 $1,100 Quitoban 3,000 250 2,750 Total $3,850
Proportion Allocation $1,100/$3,850 $ 857 $2,750/$3,850 2,143 $3,000
Sales: J-52A $5/L * 300L = $1,500; Quitoban $15/kg * 200kg = $3,000 The income per lot with the new material is expected to be: Chemicals Cosmetics Sales $1,500 $3,000 Joint cost 857 2,143 Separable cost 400 250 Income Per Lot $ 243 $ 607
Total $4,500 3,000 650 $ 850
1. Based on the calculations shown above, the gross margin of the Chemicals division is expected to decline by $27 per lot ($270-$243) if the new material is purchased. This decline is a combination of an increase in separable costs from the additional processing required by the new material, offset by a reduction in allocated joint costs under the NRV method. In addition, there may be uncertainties about the specific processing changes needed and costs involved, increasing the manager’s uncertainty about the operating results. Assuming that this manager is rewarded based on © 2012 John Wiley and Sons Canada, Ltd.
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reported division profit, she or he would not be in favour of purchasing the new material. 2. Based on the calculations shown above, the gross margin of the Cosmetics division is expected to increase by $377 per lot ($607-$230) if the new material is purchased. This increase is a combination of an increase in expected revenue caused by a selling price increase, offset by an increase in allocated joint costs under the NRV method. The manager may face significant uncertainty about whether the price increase can be achieved and how it will affect the volume of sales. As long as these risks are not too high and the Cosmetics manager is rewarded based on reported division and/or overall company profit, he/she would be in favour of purchasing the new material. 3. Many potential pros and cons could be discussed, including: Pros: Higher expected profit of $350 per lot ($850-$500) Decreased risk from lawsuits related to ingredients in the old raw material Improved product quality, which could improve brand image (as an innovative company, an ethical company, etc.) Cons: Potential conflict of interest between the Chemicals and Cosmetics managers Increased raw material and production costs Possibility that revenue and cost projections may not be met C. Many potential uncertainties could be discussed, including: Whether the revenue projections are reasonable: • Will the price increase reduce the quantity demanded? • Will the price increase attract new competition? • Will the new chemical formula lead to additional product opportunities? • Will the ingredient change have any effect on the quality and product demand of J-52A? Whether the cost projections are reasonable: • Will unforeseen production problems occur with the new ingredient? • Will the price and supply of the new ingredient be as stable as that of the old ingredient? • Will changes occur in the quantities of spoilage with the new ingredient? Health effects of the old and new raw material: • Will the new ingredient have fewer or more health risks than the old ingredient? • Will the old ingredient be found to be safe after all? How might the change in production processes and profits affect the morale and performance of managers and other employees? © 2012 John Wiley and Sons Canada, Ltd.
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D. Students may propose a variety of incentive solutions, including one or more of the following: Reward managers based on company-wide income Exclude joint cost allocations from individual manager performance evaluation Allocate joint costs using the constant gross margin NRV method Allocate the Chemicals division loss in NRV ($27 per lot) to the Cosmetics division Allocate the increase in the Chemical division’s separable costs ($400-$150 = $250 per lot) to the Cosmetics division Reduce the Chemical division’s target income under the compensation plan to accommodate the change in costs Open communication among division managers and top management to ensure that all parties are adequately informed about the reasons for decisions and the effects on the company as a whole Establish rules for managers to follow (e.g., require managers to purchase the new raw material) E. The advantages and disadvantages that students discuss will depend on the option(s) they identify. Some of these advantages and disadvantages include the following: Methods that focus on company-wide income encourage managers to consider the overall benefit to the company, but might invite a “free rider” problem. Methods that focus on division performance encourage managers to make decisions to maximize division efficiency and income, but might conflict with company-wide interests (see Chapter 15 for more information about incentive problems between managers). Methods that include an allocation of joint costs necessarily involve arbitrary allocations of costs between divisions; in general, it is desirable to eliminate uncontrollable costs from evaluations of individual division performance. Methods that focus on communication can improve morale and provide better information for decision making, but may be misunderstood and do not necessarily motivate desired actions. Methods that focus on rules or instructions work for situations such as the raw material decision, where the best decision for the company can be identified and managers can be told what to do. However, it is difficult to identify all possible rules that might be needed for other decisions. F. and G. There is no one answer to these parts. Sample solutions and a discussion of typical student responses will be included in assessment guidance on the Instructor’s web site for the textbook (available at www.wiley.com/college/eldenburg).
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Use of Joint Cost Information; Strategic
This is an open ended question. Student answers will differ based on their choice of products or business. The answer must be in memo format addressed to the professor. Students must include the following information: A. An example of how joint cost information could inappropriately affect decision making and the example must be supported by references to actual products or business. B. An example of how joint cost information could improve decision making and the example must be supported by references to actual products or business. C. A strategy, and a description of how it could be implemented, to prevent the misuse of cost accounting information and explain how cost accounting information should be used to support strategic objectives. 9.45
Integrating Across the Curriculum–Economics and Governmental Regulation – Canadian Beef Industry
A. Canadian beef by-products might end up in landfills unless some alternative use can be identified. B. 1. The cost of main products would probably increase because of the loss in revenue from by-product sales and also because of increased waste disposal costs. 2. The ban would probably increase the cost of main products in other livestock industries. Currently, beef by-products are used as feed in these industries. Other sources of feed must currently cost more than beef by-products (otherwise, they would currently be used), and an increase in demand would cause the cost to be even higher. C. The ban could have both positive and negative effects. In the short term, the increase in cost would encourage meat producers to increase prices. Consumers might shift their consumption habits to purchase other, less costly sources of meat and protein. Some producers might fail financially. The ban could also have positive effects. In the short term, consumers might shift their consumption away from Canadian beef because of higher cost, negative publicity, and concerns about the long time frame for mad cow disease. But in the long term, the ban might encourage domestic and international consumers to have greater confidence in the quality of Canadian beef, leading to higher prices. D. Below is a brief description of Canadian regulators responsibilities to key stakeholder groups. •
Canadian cattle industry: The regulators are responsible for developing standards and ensuring industry compliance. When developing standards, the regulators must consider their potential effect on the Canadian cattle industry.
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Cost Management This means that regulators must sometimes weigh the social costs and benefits of its regulations against the impact on the industry. •
Other Canadian livestock industries, such as pigs and chicken: Regulators have the same responsibility for other livestock industries that they have for the cattle industry. Their decisions about beef and other mammal by-products will directly affect the well-being of other livestock industries, in addition to that of the cattle industry. Therefore, the regulators have a responsibility to weigh not only the effects of their decisions on the cattle industry but also on the competitor livestock industries.
•
Other Canadian food manufacturers: Regulator responsibilities extend to other food manufacturers. Any shift in the type of food permitted for livestock will affect other types of food manufacturers. Thus, the regulators’ responsibilities for other food manufacturers are similar to that for the other livestock industries.
•
Consumers of Canadian beef: Because of uncertainties about the source of mad cow disease in this case, the degree of risk to consumers was not clear. In addition, there were uncertainties about whether there were adverse effects from the use of beef by-products for feed to other livestock or from the use of other mammal by-products in cattle feed. These uncertainties made it difficult for regulators to adopt an appropriate policy on behalf of beef consumers. A central part of the regulators’ dilemma was a lack of consensus about the nature of their responsibility to consumers. Some people argued that the regulators were responsible for ensuring absolute consumer safety, which meant that regulators should err on the side of safety in cases of uncertainty. Others argued that the regulators were responsible only for known safety problems and that it was appropriate to weigh cattle industry and other economic factors against the interests of consumers. A further complication was the demand of consumers for low beef prices. Questions were raised about whether consumers would be willing to pay for increased safety.
E. The validity of this argument depends on one’s values and on the uncertainties described in the answer to Part D. The source of the mad cow infection was unknown, and the extent of potential infections throughout the industry was also unknown. Some experts argued that the combined probabilities of mad cow disease and human infection were very low. And, there had been no cases of brain-wasting disease related to the consumption of Canadian beef. Thus, some people argued that no serious risk existed. However, both the cattle and human forms of the disease took many years to develop, and at least some risk existed that problems would become evident in the future. It was also difficult to define an acceptable level of risk. Was it acceptable if only a small number of people were to develop a fatal brain-wasting disease? Or should the target number have been zero? F. There is no single answer to this question. The goal is for students to synthesize the issues addressed in Parts A through E into a cohesive conclusion. Students must also © 2012 John Wiley and Sons Canada, Ltd.
Chapter 9: Joint Product and By-Product Costing make difficult decisions about how factors should be weighed in light of conflicting interests.
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Chapter 9 Joint Product and By-Product Costing LEARNING OBJECTIVES Chapter 9 addresses the following questions: LO1 LO2 LO3 LO4 LO5 LO6 LO7
Describe a joint process, and explain the difference between a by-product and a main product. Allocate joint costs. Explain the factors that are considered in choosing a joint cost allocation method. Identify the relevant information for deciding whether to process a joint product beyond the split-off point. Apply the methods that are used to account for the sale of by-products. Explain how a sales mix affects joint cost allocations. Evaluate the uses and limitations of joint cost information.
These learning questions (LO1 through LO7) are cross-referenced in the textbook to individual exercises and problems.
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QUESTIONS 9.1
Some goods are produced jointly; many products result from a common process. These are called joint products. Main products have high sales value relative to other products when split-off occurs. By-products have low sales value relative to the main products’ values.
9.2
Because all of the other products are sold at $200 or more, the product that sells for only $10 would probably be considered a by-product. Main products have relatively high sales values compared to by-products.
9.3
There are two methods of recognizing revenue from by-products. The revenue can be recognized at the split-off point, or recognized at the time of sale. The treatment depends on whether the NRV is positive or negative, and also on whether it is recognized at the time of production or sale. Negative NRV is always added to joint costs. When positive NRV is recognized at time of production, it is subtracted from joint costs. When positive NRV is recognized at time of sale, it may be treated as revenue, treated as non-revenue income, or subtracted from COGS.
9.4
Products from any of the following industries would be appropriate: oil and gas, chemical, lumber products, tour companies, meat production, wheat production, milling companies.
9.5
Joint costs are product costs that cannot be separately traced to individual products, so they are indirect with respect to individual products. Separable costs are the direct costs of producing separate products (but these costs may or may not be direct with respect to individual units).
9.6
The split-off point in a joint process occurs at the point when the individual joint products become separately identifiable. All costs incurred up to the split-off point are joint costs and (assuming no further split-off points) the costs that follow are separable costs identifiable with a specific joint product.
9.7
Here are a few examples; students may think of others that are also appropriate. A professor may do some consulting work that simultaneously generates ideas for a journal article (main product), a case for a book (main product), and a problem for an exam (byproduct). A CA firm may work on client development that simultaneously produces prospective engagements for the auditing and tax services (all probably main products). A research scientist may have an individual project that results in twenty-two patentable items (some may be main products, some may be by-products, and some may be scrapped).
9.8
Once the joint product emerges, the joint cost should be viewed as a "sunk" cost; it is a past cost that should not influence subsequent product decisions. Further processing decisions should be made based on the additional revenues obtained in relation to the additional separable costs needed to obtain those revenues.
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9.9
If all joint products were sold in the period produced, costs might not need to be allocated. But for financial reporting, all production costs must be assigned to cost of goods sold and ending inventories of the joint products to match revenues and expenses.
9.10
The contribution of each product is the selling price less separable costs. Revenues and separable costs are relatively easy to identify and measure. Therefore accountants know each product’s contribution. However, if profit is defined to mean accounting income, all costs including fixed and joint costs are allocated. To allocate costs, an allocation base must be chosen. Different allocation bases result in different profit figures. Hence, the profitability of one joint product cannot be uniquely determined, but will vary with different allocation bases.
9.11
Because the products have relatively equal value, they should all be treated as main products.
9.12
To perform market based joint cost allocations (net realizable value and constant gross margin NRV), an estimate is made of the sales value of each product. Common and separable costs are known with reasonable certainty, but price may be estimated. If the market for goods is not volatile, the price can be determined from past experience. If prices change frequently, information sources such as competitor’s prices or a list of commodity prices could be used for estimates.
9.13
Following are qualitative factors that might influence managers to process a joint product beyond the split-off point. The organization may offer a product mix, and dropping one of the products could affect sales of other products, so a group of products are always processed further. An example of this would be meat related products. Even though round steak does not need to be processed further, some people want very lean hamburger and customers may shop elsewhere if lean hamburger is not sold. Manager preferences might affect the decision to process further. For example, managers of a dairy might have a preference for a particular type of cheese that other dairies do not produce, and so they continue producing it even though sales are low and the milk could be used for other products. Resource scarcity encourages managers to consider new processes for raw materials such as sawdust and wood chips. Environmental issues also influence joint product decisions. Sometimes companies choose to convert waste into a by-product that can be sold to avoid contributing to waste disposal. Another factor is the effect on employees and local communities. Managers may choose to continue additional processing even when the financial results are relatively weak to avoid closing production facilities and laying off employees.
9.14
Some by-products are valuable and could be stolen, and so internal controls and records are kept. For by-products that are unlikely to be stolen, no controls or records need to be kept. An example of a by-product that could be stolen is raw malachite, a by-product of copper production that can be further processed into cabochons for jewellery. An example of a by-product that would not need controls is whey from dairy product processing.
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Cost Management Some managers may be responsible for the success of certain main products. If the profit varies widely depending on the joint cost method used, managers of products with relatively large allocations of cost will feel that the system is unfair. It is possible that some products would even appear to be unprofitable under a particular joint cost allocation method, and managers would then be penalized unfairly. When allocated joint costs affect managers’ performance evaluations, then the “fairness” of the allocation becomes their concern.
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MULTIPLE-CHOICE QUESTIONS 9.16
SMT Ltd. manufactures three products. Production begins with a joint process, and the three outputs of the joint process are processed further to produce products L, M, and N. The outputs at split-off have no market value. Last year, the joint costs amounted to $600,000. Other data for last year are as follows: Selling price per unit Costs per unit after split-off point to complete and sell Total output at split-off point used in production Production in units Sales in units
Product L $160 $100 16,400 kg 20,000 18,000
Product M $300 $200 10,000 kg 10,000 8,000
Product N $400 $350 8,400 kg 7,000 7,000
Using the estimated (approximate) net realizable value method of joint costing, the inventory cost per unit of product M is: a) $226.91 b) $223.53 c) $221.52 d) $220.00 e) $217.24 Ans: B [L: ($160-$100) * 20,000 = $1,200,000 NRV; M: ($300-$200)*10,000 = $1,000,000 NRV; N: ($400-$350) * 7,000 = $350,000 NRV; Total NRV = $1,200,000+$1,000,000+$350,000 = $2,550,000; M: $1,000,000/$2,550,000 * $6,000,000 = $235,294 allocated joint costs M: ($235,294/10,000 ) + $200 = $223.57 total unit costs. The following information pertains to Questions 9.17 and 9.18: Omega Company manufactures three chemicals in a joint process. The manufacturing costsof the joint process include $25,000 of direct materials and $35,000 of conversion costs. All threechemicals can be sold in their unrefined form immediately after the splitoff point, or they canbe further refined before they are sold. During May, all three chemicals were further refined. Thefollowing table shows data regarding production for the month of May: Chemical A B C Sales price per litre before refining $ 20 $ 25 $ 10 Sales price per litre after refining $ 35 $ 40 $ 18 Cost of refining $28,000 $10,000 $12,000 Total output of chemical at split-off 2,500 L 1,600 L 3,000 L Total output of chemical after refining 2,300 L 1,500 L 2,700 L
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Cost Management Using the sales value at split-off method, the total joint cost allocated to Chemical A in May(rounded to the nearest hundred dollars) is: a) $21,100 b) $25,000 c) $22,600 d) $25,500 e) $33,600 Ans: B ($20*2,500)/[($20*2,500)+($25*1,600)+($10*3,000)] * ($25,000+$35,000) = $25,000
9.18
Now assume that Omega Company uses the physical measures method, that the refining processfor Chemical C also produces a hazardous by-product that must be disposed of at a cost of $5 perlitre, and that refining 1,000 L of Chemical C results in 100 L of this byproduct. For the monthof May, what effect would refining Chemical C have on Omega Company's profits as comparedwith its profits if Chemical C was sold at split-off without being further refined (rounded to thenearest $100)? a) $17,100 more profits by refining b) $20,300 less profits by refining c) $8,100 more profits by refining d) $5,100 more profits by refining e) $8,400 less profits by refining Ans: D ($18*2,700)-12,000-(300*$5) = $35,100; $35,100-($10*3,000) =$5,100 The following information pertains to Questions 9.19 and 9.20: Omega Company manufactures three chemicals in a joint process. The manufacturing costsof the joint process include $25,000 of direct materials and $35,000 of conversion costs. Allthree chemicals are then processed further before they are sold. Other pertinent data are asfollows: Chemicals A B C
9.19
Sales Value at Split-off $50,000 40,000 30,000
Separable Costs $28,000 10,000 12,000
Final Sales Value $100,000 60,000 40,000
Using the estimated net realizable value method, the joint costs allocated to ChemicalA would be: a) $16,800 b) $25,000 c) $28,800 d) $30,000 e) $33,600 Ans: C in thousands ($100-$28)/[($100-$28)+($60-$10) + ($40-$12)]*($25+$35)=$28.8
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The decision to process all three chemicals beyond the split-off point is suboptimal. If the optimaldecision had been made, the income of Omega Company would have improved by: a) $2,000 b) $10,000 c) $30,000 d) $60,000 e) $12,000 Ans: A (Only C should not be processed passed split-off. Selling C at split-off will increase revenue by $2,000).
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EXERCISES 9.21
Identifying Joint Products
A. The following are joint products 1. Sand produced with three levels of fineness. The sand is produced by processing raw dirt and includes a number of joint costs such as labour and equipment. Some of the products are processed further. 3. Milk products are joint products because they all come from one liquid that is processed further, depending on the product. 6. Airlines could be considered as incurring joint costs because a large proportion of cost is common to all of the products. The following are not joint products 2. Automobiles and trucks because either one can be manufactured without producing the other. 4. Motorcycles and mopeds because either one can be manufactured without producing the other. 5. Clothing can be manufactured in any style without producing other styles and is therefore not a joint product. B. Two other product groups would include tour services or cruise lines, products manufactured from crude oil such as gasoline, diesel, and heating oil, and many types of food products such as beverage manufacture, cereals, milling operations, and so on. 9.22
Identifying Joint and Separable Costs - Cowboy Cattle Company 1. Joint 2. Separable 3. 4. 5. 6.
Joint Joint Separable Separable
7. Joint
All cattle require veterinary work, and the cost per specific cow is incurred before the split-off point. The cost occurs after the split-off point and can be traced directly to hamburger. The cost is incurred before the split-off point. The cost is incurred before the split-off point. The cost is incurred after the split-off point, specifically for leather. The cost is incurred after the split-off point, specifically for steaks and roasts. Cost of production incurred before the split-off point.
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Profitability of Joint Products – Larry Dean
A. The total joint cost is $700, which represents the costs incurred before puppies were born. The rest of the costs are separable. First calculate the NRV by type of puppy and in total: 2 Chocolate Males [2 puppies × ($300 – $160 – $40)] $ 200 2 Yellow Males: [2 puppies × ($400 – $160)] 480 2 Yellow Females: [2 puppies × ($450 – $160)] 580 Total NRV $1,260 Then use each product’s relative proportion of NRV to allocate the joint cost: 2 Chocolate Males [($200/$1,260) × $700] 2 Yellow Males [($480/$1,260) × $700] 2 Yellow Females [$580/$1,260 × $700] Total allocated
$111.11 266.67 322.22 $700.00
B. Gross profit on sale of each puppy: Chocolate Male [$300 – $160 – $40 – ($111.11)/2)] Yellow Male [$400 – $160 – ($266.67/2)] Yellow Female [$450 – $160 – ($322.22/2)] 9.24
$ 44.44 per puppy 106.67 per puppy 128.89 per puppy
By-Product Further Processing Decision According to the following calculations, the contribution margin is higher if the byproduct is sold at the split-off point rather than processed further. Therefore, the byproduct should not be processed further. Sold at split-off: 100 x $8 = $800 Processed further: 100 x ($19 - $12) = $700
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9.25
NRV Method, Contribution Margin, Further Processing for a Service - Deluxe Tours
A. Number of passengers Revenue Incremental costs Net realizable value Allocated lease cost Margin
First-Class 100
Tourist-Class 200
$200,000 30,000 170,000 100,000 a $ 70,000
$200,000 30,000 170,000 100,000 b $ 70,000
a $200,000 lease cost * [$170,000/($170,000+$170,000] = $100,000 b $200,000 lease cost * [$170,000/($170,000+$170,000] = $100,000 B. The answer to this question depends upon what is meant by “the contribution margin generated by first-class passengers.” An accountant could determine it is $70,000, the margin after deducting a share of the lease cost. However, a more accurate reflection would be $170 per passenger, the revenue generated by first-class passengers, less the incremental costs of serving those passengers. An alternative answer is to consider the amount of margin generated by having a separate class of passengers rather than filling the entire cruise ship with tourist-class passengers. Assume that 25 tourist-class berths replaced 20 first-class berths. (Students could make any reasonable assumption concerning how many tourist-class berths would replace firstclass berths.) So, the trade-off is 25 tourist-class versus 20 first-class berths. Incremental contribution margin if first-class cabins are sold to tourist-class passengers: Contribution per passenger for first-class: $200 - $30 = $170 Contribution per passenger for tourist-class: $100 - $15 = $85 Contribution for 20 first class passengers (20 x $170) Contribution for 25 tourist class passengers (25 x $85) Additional contribution for first class
$3,400 2,125 $1,275
C. In the example above, no allocated costs were considered because they are essentially sunk costs for the decision to use the space for first-class or tourist class. Those costs are incurred either way, so only incremental contribution is analyzed.
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Four Joint Cost Allocation Methods with Sales Mix, Further Processing Decision The Palm Oil Company
A. Computation of $100,000 joint-cost allocation using four allocation methods: (1) Sales value at split-off point Sales Value at Product Split-Off Point Soap grade $ 50,000 Cooking grade 30,000 Light moisturizer 50,000 Heavy moisturizer 70,000 $200,000
Proportions 50/200 = 0.25 30/200 = 0.15 50/200 = 0.25 70/200 = 0.35
Allocation of $100,000 $ 25,000 15,000 25,000 35,000 $100,000
Proportion 100/500 = 0.20 300/500 = 0.60 50/500 = 0.10 50/500 = 0.10
Allocation of $100,000 $ 20,000 60,000 10,000 10,000 $100,000
(2) Physical volume Soap grade Cooking grade Light moisturizer Heavy moisturizer
Physical volume 100,000 litres 300,000 litres 50,000 litres 50,000litres 500,000litres
(3) Estimated Net Realizable Value Product Fine Soap Superior Cooking Oil Light moisturizer Premium Moisturizer
Estimated Final Sales Separable Value Costs $300,000 $200,000 100,000 80,000 50,000 0 120,000 90,000
Net Realizable Value $100,000 20,000 50,000 30,000 $200,000
Allocation Proportion of $100,000 100/200=0.50 $ 50,000 20/200=0.10 10,000 50/200=0.25 25,000 30/200=0.15 15,000 $100,000
(4) Constant Gross Margin Method First calculate the gross profit margin ratio for all products: Product Final Sales Value Fine Soap $300,000 Superior Cooking Oil 100,000 Light Moisturizer 50,000 Premium Moisturizer 120,000 Total $570,000 Less joint costs Gross margin
Separable Costs $200,000 80,000 0 90,000 $370,000
Gross profit margin ratio = $100,000/$570,000 = 0.175439 © 2012 John Wiley and Sons Canada, Ltd.
Contribution $100,000 20,000 50,000 30,000 200,000 100,000 $100,000
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Second, apply the gross profit margin ratio to each product to determine cost of goods sold. Then subtract separable costs from cost of goods sold to determine the joint cost allocation for each product. Product Fine Soap Superior Cooking Oil Light Moisturizer Premium Moisturizer
Revenue $300,000 100,000 50,000 120,000 $570,000
Gross Margin* $ 52,632 17,544 8,772 21,052 $100,000
Separable Allocation Costs of $100,000 $200,000 $ 47,368 80,000 2,456 0 41,228 90,000 8,948 $100,000
COGS 247,368 82,456 41,228 98,948
* Gross margin = Revenue x Gross profit margin ratio = Revenue x 0.175439 B. Contribution from Processing Soap Grade into Fine Soap: Incremental revenue = $300,000 - 50,000 Incremental costs Incremental operating income
$250,000 200,000 $ 50,000
Contribution from Processing Cooking grade oil into Superior Cooking Oil: Incremental revenue = $100,000 - 30,000 $ 70,000 Incremental costs 80,000 Incremental operating income $(10,000) Contribution from Processing Heavy Moisturizer into Premium Moisturizer: Incremental revenue = $120,000 - 70,000 $ 50,000 Incremental costs 90,000 Incremental operating income $(40,000) Operating income can be increased by $50,000 if both Cooking Grade Oil and Heavy Moisturizers are sold at the split-off point. Soap Grade should continue to be processed further. 9.27
Sales Value at Split-Off, Physical Output, NRV Methods,Further Processing Decision - Flowering Friends
A. 1. Sales value at split-off point method Premium Regular
Sales Value at Split-off Point ($5*2,000) $10,000 ($3*8,000) 24,000 $34,000
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Percent 29% 71 100%
Allocation of $15,000 $ 4,350 10,650 $15,000
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2. Physical output method Number of Pots 2,000 8,000 10,000
Percent 20% 80 100%
Allocation of $15,000 $ 3,000 12,000 $15,000
Net Realizable Value ($25*2,000) $ 50,000 ($10*8,000) 80,000 $130,000
Percent 38% 62 100%
Allocation of $15,000 $ 5,700 9,300 $15,000
Premium Regular 3. Net realizable value method Premium Regular
B. Based on a comparison of the contributions for each alternative, the company should process further: Sell as premium Process further ($35 – $20/4 - $3) Extra contribution from processing further 9.28
$25 27 $ 2
NRV and Physical Output Methods, Further Processing Decision - Click and Clack Recyclers
A. There are no separable costs for these products, so each product’s net realizable value is the revenue per litre. However, one litre of oil yields 0.7 motor oil and 0.3 fuel oil, so for each litre of oil produced, the total NRV is 0.7*$3 + 0.3*$1.50 = $2.55. The total costs per litre are $0.75 + $1.25 = $2.00. The inventory cost per litre of residual fuel oil is ($1.50*0.3)/$2.55*$2.00 = $0.3529 B. If allocated cost were based on physical output, the cost per litre for residual fuel oil is 0.3*$2.00 = $0.60. C. Special fuel would need to match the contribution for residual fuel oil. The contribution for residual fuel oil is $1.50 per litre. The minimum acceptable price for Special Fuel Oil is $1.50 plus the $0.40 per litre for additional processes or $1.90 per litre. At this price the managers would be indifferent to selling residual oil or processing it further.
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9.29
By-product Value Recognized at Time of Production Versus Time of Sale - Mile High Lumber Mill
A. Income Statement with By-Product Value Recognized at the Time of Sale Revenue: Lumber (270,000 BF x $3) Scraps (900 logs x $10) Total Revenue Cost of Goods Sold (270,000BF x $2a) Gross Margin a
$810,000 9,000 819,000 540,000 $279,000
Cost is calculated as follows: $600,000/300,000 bd ft = $2 per BF
B. Income Statement with By-Product Value Recognized at the Time of Production Value of inventory for the main product: Joint product costs incurred Less NRV of by-product (1,000 logs x $10) Net joint product cost
$600,000 10,000 $590,000
Product cost per board foot ($590,000/300,000 bd ft)
$1.966667
Income statement: Revenue (270,000 BF x $3.00) Cost of Goods Sold (270,000 BF x $1.966667) Gross Margin
$810,000 531,000 $279,000
Notice that there is no difference between gross margins under the two methods. This will be true only under rigid conditions: (1) the proportion of main products sold is equal to the proportion of by-products sold during the period, and (2) there is either no beginning inventory or by-products in beginning inventory are sold for the exact amount estimated during the prior period. However, as long as by-product values are immaterial, the methods have little effect on the income statement and balance sheet. 9.30
Physical Output, NRV, and Constant Gross Margin NRV Methods,Further Processing Decision - The Paint Palette Company
A. Physical output method: For Premium: (30% * $10,000) For regular: (70% * $10,000) Total allocated © 2012 John Wiley and Sons Canada, Ltd.
$ 3,000 7,000 $10,000
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B. NRV method For premium [30%*4,000 litres * ($5 - $1)] For regular [70%*4,000 litres * ($2.5 – $.25)] Total NRV
$ 4,800 6,300 $11,100
Allocation: Allocated to premium ($4,800/$11,100)*$10,000 Allocated to regular ($6,300/$11,100)*$10,000 Total allocated costs
$ 4,324 5,676 $10,000
C. Constant Gross Margin NRV Method First, determine gross margin percentage: Total revenue (30%*4,000*$5)+ (70%*4,000*$2.5) Less: Separable costs ($1*4,000*30%) + ($.25*4,000*70%) $ 1,900 Common costs 10,000 Gross margin Gross margin percentage ($1,100/$13,000)
$13,000 11,900 $ 1,100 8.46153%
Next, allocate common cost: Revenue Gross Margin Separable costs Allocated Common Cost
Premium $6,000 (508) (1,200) $4,292
Regular $7,000 (592) (700) $5,708
D. Compare the contribution per litre of the two alternatives: Contribution per litre if processed further ($22 - $11 - $1) Continue with current process: ($10 - $.25x4) Increase in contribution per litre if process further
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$10 9 $ 1
Total $13,000 (1,100) (1,900) $10,000
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9.31
Calculate Missing Information for Sales Value at Split-off Point Method - The Chile Salsa Company This problem can be solved in a series of steps, where the answers for some parts are needed to answer others. If joint costs are allocated based on the sales value at split-off point method, the joint costs for Spicy Hot are: ($25,000/$100,000) * $60,000 = $15,000 (1) Therefore, the joint cost for Medium is ($60,000 - $24,000 - $15,000) = $21,000 (2) Now the values for sales at split-off for medium and mild can be calculated: Medium: [($21,000/$60,000)*$100,000] = $35,000 (3) Mild: ($100,000 - $35,000 - $25,000) = $40,000 (4)
Units produced Joint costs Sales value at split-off point Additional cost if process further Sales value if processed further
Mild 24,000 $24,000 (4) $40,000 $9,000 $55,000
Medium ? (2)$21,000 (3) $35,000 $7,000 $45,000
Spicy Hot ? (1)$15,000 $25,000 $5,000 $30,000
Total 48,000 $60,000 $100,000 $21,000 $130,000
Notice that the information about units produced was irrelevant in this problem. 9.32
Further Processing Profit and Decision - Conrad Miller
A. Allocation for Very Flexible under the sales value at split-off point method: $120,000/($1,500,000) * $900,000 = $72,000 Gross profit: Revenue – Separable costs – Allocated joint costs = $135,000 - $12,000 - $72,000 = $51,000 B. Based on a comparison of the contribution of the two alternatives, the company should process further: Sell at split-off Process further ($135,000 - $12,000) Contribution from processing further © 2012 John Wiley and Sons Canada, Ltd.
$120,000 123,000 $ 3,000
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Accounting for Main Products and By-products - Nutri-Smoothie
A. Gross margin if by-product value is recognized at time of production Value of inventory for main product Joint product costs incurred $12,000 Less NRV of by-product (2,000) Net joint product cost $10,000 Income statement Revenue (18,000 * $2.00) $36,000 Joint costs ($10,000/20,000 *18,000) (9,000) Gross margin $27,000 B. Gross margin if by-product value is recognized at the time of sale Revenues: Smoothies (18,000 * $2.00) $36,000 Revenues: Compost 2,000 Total revenue 38,000 Joint Costs ($12,000/20,000)*18,000 (10,800) Gross Margin $27,200 C. Inventories if by-product value is recognized at the time of production: Smoothies ($10,000/20,000 *2,000) $1,000 Compost ($2,000/8,000 * 2,000) 500 Ending Inventories if by-product value is recognized at the time of sale: Smoothies ($12,000/20,000 *2,000) $1,200 Compost 0
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PROBLEMS 9.34
Identifying Joint Costs, Choice of Allocation Method - Roses to Go
A. Roses to Go must pay someone to water and tend to the roses. The company must pay for labour to cut the roses. It pays for fertilizer and water and depreciation on any buildings used in the production and cutting process. If the roses are cooled after cutting, the cost of cooling must be paid. All of these are joint costs. B. Use the physical volume method because it is the most simple and will not distort costs if there is little difference in the packaging and pricing of the products. C. If there are different prices, the sales value at split-off point method would work best here because the separable costs would be very similar. This method is most simple and would be the best choice because it does not distort the costs. 9.35
NRV, Processing Further Decision – Deepa Company
A. First calculate the NRV for Products 1 and 2: Product 1 ($4 × 10,000 kg) Product 2 [($3 – $2) × 30,000 kg] Total NRV
$40,000 30,000 $70,000
Notice that the joint costs ($55,000 + $65,000 = $120,000) are greater than the total NRV, and so the products are unprofitable. Next, allocate joint costs based on NRV: Product 1 [($40,000/$70,000) × $120,000)] Product 2 [($30,000/$70,000) × $120,000)] Total Allocated
© 2012 John Wiley and Sons Canada, Ltd.
$ 68,571 51,429 $120,000
Chapter 9: Joint Product and By-Product Costing Finally, calculate the gross profit for pounds sold by product line and total: Product 1 Sales Revenue: Product 1 (7,000 kgs× $4 per kg) Product 2 (26,000 kgs× $3 per kg) Separable Costs: Product 2 (26,000 kgs× $2 per kg) Joint Costs: Product 1 [(7,000/10,000) × $68,571] Product 2 [(26,000/30,000) × $51,429] Gross Margin (Loss)
Product 2
$ 28,000 $ 78,000 0 48,000 _______ ($20,000)
52,000
44,572 ($18,572)
B. Under the new assumptions the calculation of gross profit is as follows: First calculate the NRV for Products 1 and 2: Product 1 ($5× 10,000 kg)-$20,000 Product 2 [($3 – $2) × 30,000 kgs] Total NRV
$30,000 30,000 $60,000
Notice that the joint costs ($55,000 + $65,000 = $120,000) are greater than the total NRV, and so the products are unprofitable. Next, allocate joint costs based on NRV: Product 1 [($30,000/$60,000) × $120,000)] Product 2 [($30,000/$60,000) × $120,000)] Total Allocated
$ 60,000 60,000 $120,000 Product 1
Sales Revenue: Product 1 (10,000 kg× $5 per kg) Product 2 (30,000 kg× $3 per kg) Separable Costs: Product 1 ($20,000 per 10,000 kg) Product 2 (30,000 kg× $2 per kg) Joint Costs (per 10,000 kgand 30,000 kg) Gross Margin (Loss)
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Product 2
$ 50,000 $ 90,000 20,000 60,000 ($30,000)
60,000 60,000 ($30,000)
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Cost Management C. Compare the contribution when Product1 is sold “as is” and when it is processed further: When sold “as is” ($4 per kg × 10,000 kg) When processed further [($5 per kg× 10,000 kg) – $20,000]
$40,000 $30,000
Based solely on quantitative factors, Product 1 should be sold “as is” after its joint production with Product 2. 9.36
NRV – Ali Chemical Company
A. The joint costs are incurred prior to either product’s individual processing: The cost to purchase the mixture The cost to process the mixture into the products Total Joint Costs
$5,000 1,500 $6,500
B. The separable costs for each product are calculated as follows: SLX-241 ($2 per litre× 400 litres)
$800
QY-58 ($0.50 per kg × 200 kg of inert substance)
$100
C. Determine the NRV of each product: SLX-241 [($8 per litre× 400 litres) – $800] QY-58 [($6 per kg × 1,000 kg) – $100] Total NRV
$2,400 5,900 $8,300
Note: The total volume of QY-58 is equal to the original volume at the split-off point of 800 kg plus the additional inert substance of 200 kg, or a total of 1,000 kg. Based on the relative NRV values, the joint costs are allocated as follows: SLX-241 [($2,400/$8,300) × $6,500] QY-58 [($5,900/$8,300) × $6,500] Total Allocation
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$1,880 4,620 $6,500
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The cost per unit of each product is then calculated as follows: Joint Costs Separable Costs (from Part A) Total Costs per Product
SLX-241 $1,880 800 $2,680
Number of units produced Cost per Unit 9.37
QY-58 $4,620 100 $4,720
400 litres
1,000 kg
$6.70 per litre
$4.72 per kg
Separable and Joint Costs, NRV, Operating Income, By-product - Doe Corporation The following chart traces the physical flow of the products and summarizes cost and sales information.
Slicing Crushing Juicing Animal Feed Total
Weight After Total Weight Evaporation Loss 94,500 kg (35%*270,000) 75,600 kg (28%*270,000) 72,900 kg 67,500 kg (27%*270,000) (72,900/1.08) 27,000 kg (10%*270,000) 270,000 kg
Costs $ 4,700 10,580 3,250 700 $19,230
Total Revenue $ 56,700 ($0.60*94,500) 41,580 ($0.55*75,600) 20,250 ($0.30*67,500) 2,700 ($0.10*27,000) $121,230
A. The total weights are obtained by multiplying the initial 270,000 kilograms by the proportion of product by weight transferred to departments given. See table above. B. Product Slices Crushed Juice Total
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Selling price $ 56,700 41,580 20,250 $118,530
Separable cost $ 4,700 10,580 3,250 $18,530
NRV $ 52,000 31,000 17,000 $100,000
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Cost Management C. None of the costs are assigned to the by-product. The allocation of the $60,000 of cutting department costs to the main products is reduced by $2,000 ($2,700 - $700) for the NRV of animal feed (the by-product), so $58,000 is allocated Product Slices Crushed Juice Total
NRV $ 52,000 31,000 17,000 $100,000
Proportion 52% 31% 17%
Allocation $30,160 17,980 9,860 $58,000
D. Sales Joint cost Separable cost Gross margin
Slices $56,700 30,160 4,700 $21,840
Crushed $41,580 17,980 10,580 $13,020
Juice $20,250 9,860 3,250 $ 7,140
Total $118,530 58,000 18,530 $ 42,000
E. The gross margin information is of little value to management. As long as the overall processing is profitable, the net realizable value approach will show each of the products as valuable. For product mix decisions (such as whether to produce more juice and less crushed pineapple), information is needed about incremental revenues and costs rather than gross margin data. F. If there is no disposal revenue, the additional costs are $800 to dispose of the outside skin plus $2,700 in lost revenue (assuming that $700 of chopping costs would not be increased). The $3,500 would be added to each product in the same proportions as in part C. Thus the correct additional costs would be: Slices Crushed Juice Total
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Additional Cost $1,820 1,085 595 $3,500
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Cumulative Problem (Chapter 4): Optimal Product Mix, Joint Cost Allocation Using Three Methods – Aromasoaps
[Note: This problem requires application of knowledge from Chapter 4.] A sample spreadsheet using Excel Solver for this problem is available on the Instructor’s web site for the textbook (available at www.wiley.com/canada/eldenburg). Below are manual calculations. A. Incremental profit from further processing: Relaxation Energizer Harmony
Incremental Revenue* Incremental Cost [$15,000 – (3,000 × $2)] = $9,000 $ 8,000 [$72,000 – (12,000 × $4)] = $24,000 20,000 [$73,000 – (33,000 × $2)] = $7,000 10,000
Net $ 1,000 4,000 (3,000)
* Incremental revenue is calculated as the difference between total revenue after processing and total revenue at the split-off point for each product. Relaxation and Energizer should be processed beyond the split-off point. Further processing of Harmony yields an incremental loss of $3,000, so it should not be processed further. B. Profit from the optimal sales mix: Relaxation $15,000 8,000
Sales Processing Joint Cost Income
Energizer $72,000 20,000
Harmony $66,000 0
C. Joint cost allocation under the physical volume method: Relaxation Energizer Harmony Total
Number of Units 3,000 12,000 33,000 48,000
Proportion 3,000/48,000 12,000/48,000 33,000/48,000
Allocation $ 5,625 22,500 61,875 $90,000
D. First calculate NRV, assuming the optimal sales mix: Relaxation ($15,000 – $8,000) Energizer ($72,000 - $20,000) Harmony (sold at split-off point) Total NRV © 2012 John Wiley and Sons Canada, Ltd.
$
7,000 52,000 66,000 $125,000
Total $153,000 28,000 90,000 $ 35,000
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Cost Management Then use the NRV calculations to allocate joint costs: Relaxation [($7,000/$125,000) × $90,000] Energizer [($52,000/$125,000) × $90,000] Harmony [($66,000/$125,000) × $90,000] Total Allocation
$ 5,040 37,440 47,520 $90,000
E. Joint cost allocation using final sales value of $153,000 (from part B): Relaxation [($15,000/$153,000) × $90,000] Energizer [($72,000/$153,000) × $90,000] Harmony [($66,000/$153,000) × $90,000] Total Allocation
$
8,823 42,353 38,824 $90,000
It is inappropriate to use final sales value to allocate joint costs because it ignores the additional costs incurred to earn the additional revenues. F. This part requires recalculation of the apparent optimal sales mix according to gross margins calculated using the joint cost allocations from Parts C, D, and E. PHYSICAL OUTPUT METHOD Gross Margins if Sold at the Split-Off Point: Relaxation Energizer Harmony
Revenue $ 6,000 (3,000 × $2) 48,000 (12,000 × $4) 66,000 (33,000 × $2)
Gross Margins if Processed Further: Separable Revenue Cost Relaxation $15,000 $ 8,000 Energizer 72,000 20,000 Harmony 73,000 10,000
Joint Cost Allocation $ 5,625 22,500 61,875
Gross Margin $ 375 25,500 4,125
Joint Cost Allocation $ 5,625 22,500 61,875
Gross Margin $ 1,375 29,500 1,125
Under the physical output method, Relaxation and Energizer would be processed further, but not Harmony. This is same as the optimal sales mix (Part B). However, this result will not always hold. With a different set of values, the apparent optimal sales mix using gross margins could be different than the actual optimal sales mix.
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NRV METHOD Note: The calculations shown below assume that the joint cost allocations from Part D would not be affected by changes in the managers’ decisions to process a product further. Gross Margins if Sold at the Split-Off Point: Relaxation Energizer Harmony
Revenue $ 6,000 48,000 66,000
Gross Margins if Processed Further: Separable Revenue Cost Relaxation $15,000 $ 8,000 Energizer 72,000 20,000 Harmony 73,000 10,000
Joint Cost Allocation $ 5,040 37,440 47,520
Gross Margin $ 960 10,560 18,480
Joint Cost Allocation $ 5,040 37,440 47,520
Gross Margin $ 1,960 14,560 15,480
Under the NRV method, Relaxation and Energizer would be processed further, but not Harmony. This is same as the optimal sales mix (Part B). FINAL SALES VALUE METHOD Note: The calculations shown below assume that the joint cost allocations from Part E would not be affected by changes in the managers’ decisions to process a product further. Gross Margins if Sold at the Split-Off Point: Relaxation Energizer Harmony
Revenue $ 6,000 48,000 66,000
Gross Margins if Processed Further: Separable Revenue Cost Relaxation $15,000 $ 8,000 Energizer 72,000 20,000 Harmony 73,000 10,000
Joint Cost Allocation $ 8,823 42,353 38,824
Gross Margin $ (2,823) 5,647 27,176
Joint Cost Allocation $ 8,823 42,353 38,824
Gross Margin $ (1,823) 9,647 24,176
Under the final sales value method, Relaxation and Energizer would be processed further, but not Harmony. This is same as the optimal sales mix (Part B). However, this result will not always hold. With a different set of values, the © 2012 John Wiley and Sons Canada, Ltd.
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Cost Management apparent optimal sales mix using gross final sales values could be different than the actual optimal sales mix.
9.39
Physical Output Method, Drop a Product, Special Order - Jumping Juice Ltd.
A. According to the requirements of the problem, the costs of the vat process need to be allocated, which would amount to $30,000 [=$5,000 + $250*100]. Allocation base: Volume Relative volume
Standard Grade 20,000 bottles 2/3
Allocated cost of vat process: Standard (2/3*$30,000) Premium (1/3*$30,000)
Premium Grade 10,000 bottles 1/3
$20,000 $10,000
Cost of handling and bottling: Standard ($1,000+$100*200 barrels) Premium ($2,000+$200*100 barrels)
21,000 ______
22,000
Total cost
$41,000
$32,000
20,000 bottles
10,000 bottles
Divided by volume Cost per bottle
$2.05
$3.20
B. Allocation base: Volume Relative volume Allocated variable joint cost: Standard (2/3*$250*100) Premium (1/3*$250*100)
Standard Grade 20,000 bottles 2/3
Premium Grade 10,000 bottles 1/3
$16,667 $8,333
Variable cost of handling and bottling: Standard ($100*200) Premium ($200*100)
20,000 ______
20,000
Total variable cost
$36,667
$28,333
Divided by volume
20,000 bottles
10,000 bottles
Variable cost per bottle
© 2012 John Wiley and Sons Canada, Ltd.
$1.83
$2.83
Chapter 9: Joint Product and By-Product Costing C.
As Is Production: Standard Grade Premium Grade Revenue As Is ($3*20,000+$5*10,000) All Premium Grade ($5*30,000)
20,000 bottles 10,000 bottles
All Premium Grade 30,000 bottles
$110,000 $150,000
Joint Costs As Is ($5,000+$250*100) All Premium Grade (same)
(30,000) (30,000)
Handling and bottling: Standard grade: As Is ($1,000+$100*200) Discontinue Standard
(21,000) (0)
Premium grade: As Is ($2,000+$200*100) All Premium Grade ($2,000 + $200 * 300) Profit (Loss)
160
(22,000) (62,000) $ 37,000
$ 58,000
Profit would increase from $37,000 to $58,000 if all raw cider was treated as premium grade. . D. If a special order of premium cider were produced without producing any standard cider, the decision to produce premium would require incurring the fixed and variable vat costs, as well as the fixed and variable costs for premium bottling. The special order would need to pay for all of these costs. 9.40
Identify Joint Costs in Complex Process, Income Statement, By-Product, Opportunity Cost – Goodman and Sons
A. Joint costs of producing Product A and Product B is the sum of Department 1 and Department 2 costs: $10,000 + $10,000 = $20,000 Note: If the by-product (produced in department 3) had a negative NRV, then the negative NRV would also be included in the joint costs. However, department 3 generates positive incremental cash flows, so the by-product NRV will be recognized according to the company’s policy (at time of sale). B. Allocation of joint costs using the NRV method: © 2012 John Wiley and Sons Canada, Ltd.
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Product A Product B Total
Separable Revenue Costs NRV $40,000 $25,000 $15,000 6,000 5,000 1,000 $16,000
Joint Cost Proportion Allocation $15,000/$16,000 $18,750 $1,000/$16,000 1,250 $20,000
C. Income Statement using the NRV method and assuming that all products are sold (i.e., no beginning or ending inventories): Revenue ($40,000 + $6,000) Cost of goods sold: Joint costs Separable costs ($25,000 + $5,000) By-product NRV ($10,000 – $2,000) Gross Margin
$46,000 $20,000 30,000 (8,000)
42,000 $ 4,000
Note: The by-product NRV of $8,000 could be subtracted from cost of goods sold (as shown above). Alternatively, it could have been included in revenues or listed below gross margin as other income. D. Because no market exists for intermediate products, the opportunity cost of Product B for purposes of determining whether it should be processed further is its net realizable value of $1,000. 9.41
Joint Product, By Products, Weighted-Average Process Costing - S-T Inc. Physical Flow WIP beginning Started Completed and transferred out Ending WIP
2 batches (30% and 80% converted) 21 batches 20 batches 1 batch (50% converted)
Equivalent units and costs under weighted average. Remember that under weighted average, beginning inventory is counted as part of units completed. Also remember that direct material and conversion costs from work completed on beginning inventory and costs incurred this period are summed. Following are the equivalent units and costs under weighted average.
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Equivalent Units (Batches) Work performed this period: Materials Conv. Costs Units completed 20.0 20.0 Ending inventory (50% complete) 1.0 0.5 Total 21.0 20.5 Costs to account for: Beginning WIP Current costs Total
Materials $ 8,550 71,250 $79,800
Conv. Costs $ 3,007 40,740 $43,747
Cost per equivalent unit
$3,800
$2,134
Total $ 11,557 111,990 $123,547 $5,934
Process Cost Report – Weighted Average Method Units completed ($5,934 x 20) Ending inventory Materials ($3,800 x 1.0) Conversion ($2,134 x 0.5) Total ending WIP Total costs accounted for
$118,680 $3,800 1,067 4,867 $123,547
By-product Z is valued at its estimated selling price of $1 per litre. This amount is subtracted from the cost of batches completed to arrive at the net amount of joint costs to be allocated: Cost of goods completed (calculated above) Less by-product sales (20 batches x 100 L x $1) Net joint cost
$118,680 (2,000) $116,680
Note that the firm produced 400 L x 20 batches = 8,000 litres of X and 500 L x 20 batches = 10,000 litres of Y. Given these volumes, the joint costs are allocated to each product as follows under the net realizable value method Litres Price per litre Separable costs per litre
Product X 8,000 $8 $2
Product Y 10,000 $11 $3
Sales revenue Separable costs NRV
$64,000 16,000 $48,000
$110,000 30,000 $ 80,000
Total
$174,000 46,000 $128,000
The final step is to calculate the total costs assigned to each product and then calculate the total cost per litre:
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Cost Management Product X Allocation of joint costs: X: $116,680 x ($48/$128) Y: $116,680 x ($80/$128) Separable costs Total Cost
Product Y
$43,755 16,000 $59,755
$ 72,925 30,000 $102,925
Divided by litres
8,000
10,000
Total Cost per litre
$7.47
$10.29
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MINI-CASES
9.42
Profit at Split-off Point and After Further Processing, Manager Incentives and Decisions - Champion Chip Company First translate amounts to Canadian dollars and total. Deluxe Superior Sales value at split-off point If process further: Sales value Separable costs
Good
Total
400£*2 = $800
3,200 HK$*0.125 = $400
Cdn$200
CAD$1,400
550£*2=$1,100 200£*2 = $400
4,800 HK$*0.125=$600 800 HK$*0.125=$100
Cdn$800 Cdn$500
CAD$2,500 CAD$1,000
Good $200
Total $1,400 1,000
143 $ 57
______ $ 400
A. Sales Joint costs: Deluxe ($800/$1,400)*$1,000 Superior ($400/$1,400)*$1,000 Good ($200/$1,400)*$1,000 Pre-tax income
Deluxe $800
Superior $400
571 286 $229
$114
B. Below is the proforma income statement if only the Deluxe chip is processed further. The Deluxe manager will choose to sell at split-off point (income of $229 versus $53) Sales Separable costs Net realizable value Joint costs: Deluxe ($1,100/$1,700)*$1,000 Superior ($400/$1,700)*$1,000 Good ($200/$1,700)*$1,000 Pre-tax income
© 2012 John Wiley and Sons Canada, Ltd.
Deluxe $1,100 400 700
Superior $400 0 400
Good $200 0 200
Total $1,700 400 1,300 1,000
118 $ 82
______ $ 300
647 235 $ 53
$165
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Cost Management Below is the proforma income statement if only the Superior chip is processed further. The Superior manager will choose to process further (income of $125 versus $114) Sales Separable costs Net realizable value Joint costs: Deluxe ($800/$1,600)*$1,000 Superior ($600/$1,600)*$1,000 Good ($200/$1,600)*$1,000 Pre-tax income
Deluxe $800 0 800
Superior $600 100 500
Good $200 0 200
Total $1,600 100 1,500 1,000
125 $ 75
______ $ 500
500 375 $300
$125
Below is the proforma income statement if only the Good chip is processed further. The Good manager will choose to sell at the split-off point (income of $57 versus a loss of $100). Sales Separable costs Net realizable value Joint costs: Deluxe ($800/$2,000)*$1,000 Superior ($400/$2,000)*$1,000 Good ($800/$2,000)*$1,000 Pre-tax income
Deluxe $800 0 800
Superior $400 0 400
Good $800 500 300
Total $2,000 500 1,500 1,000
400 $(100)
______ $ 500
400 200 $400
$200
C. The best decisions for the firm are for each division to bring in the highest contribution. For Deluxe, selling at the split-off point is best ($800 at split-off point versus $700 if processed further). For Superior, process further ($500 for processing further versus $400 for selling at split-off). For Good, process further ($300 for further processing versus $200 at split-off point). D. Below is the proforma income statement if all managers make best decision for their division: Sales Separable costs Net realizable value Joint costs: Deluxe ($800/$1,600)*$1,000 Superior ($600/$1,600)*$1,000 Good ($200/$1,600)*$1,000 Pre-tax income © 2012 John Wiley and Sons Canada, Ltd.
Deluxe $800 0 800
Superior $600 100 500
Good $200 0 200
Total $1,600 100 1,500 1,000
125 $ 75
______ $ 500
500 375 $300
$125
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Below is the proforma income statement if all managers make the optimal decision for overall profitability Sales Separable costs Net realizable value Joint costs: Deluxe ($800/$2,200)*$1,000 Superior ($600/$2,200)*$1,000 Good ($800/$2,200)*$1,000 Pre-tax income
Deluxe $800 0 800
Superior $600 100 500
Good $800 500 300
Total $2,200 600 1,600 1,000
363 $ (63)
______ $ 600
364 273 $436
$227
Notice that the choice of an accounting procedure encourages the managers to act in their own interest instead of the interest of the firm as a whole. E. Note that if the net realizable value method is used to allocate the joint cost, the managers will reach the following stable solution. The allocation of joint costs would be
Deluxe Superior Good
Eventual Selling Separable Price Costs $800 $ 0 600 100 800 500
Net Realizable Value $ 800 500 300 $1,600
Allocation 8/16(1000) $ 500.00 5/16(1000) 312.50 3/16(1000) 187.50 $1,000.00
Given this allocation, the income statement would be: Sales Joint Further processing Pre-tax Income
Deluxe $800 500 $300
Superior $600 312 100 $188
Good $800 188 500 $112
Total $2,200 1,000 600 $ 600
F. Managers often act in the best interest of their divisions. If allocations are used to determine the income of divisions, the allocations may distort the profitability of each division, relative to the entire company. G. Bonuses should be based on a combination of factors, both financial and non-financial, and on the profitability of both divisions and the entire corporation. This type of incentive structure encourages managers to maximize efforts that lead to best overall profitability for the entire corporation.
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9.43
NRV Method, Division Manager Incentives, Qualitative Factors - Hudziak Industries
A. Allocation of joint costs: Ingredient J-52A Quitoban Total
Sales Value $1,500 1,400
Separable Cost $150 250
Net Realizable Value $1,350 1,150 $2,500
Proportion Allocation $1,350/$2,500 $1,080 $1,150/$2,500 920 $2,000
Sales: J-52A $5/L * 300L = $1,500; Quitoban $7/kg * 200kg = $1,400 Income per lot: Sales Joint cost Separable cost Income Per Lot
Chemicals $1,500 1,080 150 $ 270
Cosmetics $1,400 920 250 $ 230
Total $2,900 2,000 400 $ 500
B. The allocation of the cost of the new material would be: Net Sales Separable Realizable Ingredient Value Cost Value J-52A $1,500 $400 $1,100 Quitoban 3,000 250 2,750 Total $3,850
Proportion Allocation $1,100/$3,850 $ 857 $2,750/$3,850 2,143 $3,000
Sales: J-52A $5/L * 300L = $1,500; Quitoban $15/kg * 200kg = $3,000 The income per lot with the new material is expected to be: Chemicals Cosmetics Sales $1,500 $3,000 Joint cost 857 2,143 Separable cost 400 250 Income Per Lot $ 243 $ 607
Total $4,500 3,000 650 $ 850
1. Based on the calculations shown above, the gross margin of the Chemicals division is expected to decline by $27 per lot ($270-$243) if the new material is purchased. This decline is a combination of an increase in separable costs from the additional processing required by the new material, offset by a reduction in allocated joint costs under the NRV method. In addition, there may be uncertainties about the specific processing changes needed and costs involved, increasing the manager’s uncertainty about the operating results. Assuming that this manager is rewarded based on © 2012 John Wiley and Sons Canada, Ltd.
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reported division profit, she or he would not be in favour of purchasing the new material. 2. Based on the calculations shown above, the gross margin of the Cosmetics division is expected to increase by $377 per lot ($607-$230) if the new material is purchased. This increase is a combination of an increase in expected revenue caused by a selling price increase, offset by an increase in allocated joint costs under the NRV method. The manager may face significant uncertainty about whether the price increase can be achieved and how it will affect the volume of sales. As long as these risks are not too high and the Cosmetics manager is rewarded based on reported division and/or overall company profit, he/she would be in favour of purchasing the new material. 3. Many potential pros and cons could be discussed, including: Pros: Higher expected profit of $350 per lot ($850-$500) Decreased risk from lawsuits related to ingredients in the old raw material Improved product quality, which could improve brand image (as an innovative company, an ethical company, etc.) Cons: Potential conflict of interest between the Chemicals and Cosmetics managers Increased raw material and production costs Possibility that revenue and cost projections may not be met C. Many potential uncertainties could be discussed, including: Whether the revenue projections are reasonable: • Will the price increase reduce the quantity demanded? • Will the price increase attract new competition? • Will the new chemical formula lead to additional product opportunities? • Will the ingredient change have any effect on the quality and product demand of J-52A? Whether the cost projections are reasonable: • Will unforeseen production problems occur with the new ingredient? • Will the price and supply of the new ingredient be as stable as that of the old ingredient? • Will changes occur in the quantities of spoilage with the new ingredient? Health effects of the old and new raw material: • Will the new ingredient have fewer or more health risks than the old ingredient? • Will the old ingredient be found to be safe after all? How might the change in production processes and profits affect the morale and performance of managers and other employees? © 2012 John Wiley and Sons Canada, Ltd.
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D. Students may propose a variety of incentive solutions, including one or more of the following: Reward managers based on company-wide income Exclude joint cost allocations from individual manager performance evaluation Allocate joint costs using the constant gross margin NRV method Allocate the Chemicals division loss in NRV ($27 per lot) to the Cosmetics division Allocate the increase in the Chemical division’s separable costs ($400-$150 = $250 per lot) to the Cosmetics division Reduce the Chemical division’s target income under the compensation plan to accommodate the change in costs Open communication among division managers and top management to ensure that all parties are adequately informed about the reasons for decisions and the effects on the company as a whole Establish rules for managers to follow (e.g., require managers to purchase the new raw material) E. The advantages and disadvantages that students discuss will depend on the option(s) they identify. Some of these advantages and disadvantages include the following: Methods that focus on company-wide income encourage managers to consider the overall benefit to the company, but might invite a “free rider” problem. Methods that focus on division performance encourage managers to make decisions to maximize division efficiency and income, but might conflict with company-wide interests (see Chapter 15 for more information about incentive problems between managers). Methods that include an allocation of joint costs necessarily involve arbitrary allocations of costs between divisions; in general, it is desirable to eliminate uncontrollable costs from evaluations of individual division performance. Methods that focus on communication can improve morale and provide better information for decision making, but may be misunderstood and do not necessarily motivate desired actions. Methods that focus on rules or instructions work for situations such as the raw material decision, where the best decision for the company can be identified and managers can be told what to do. However, it is difficult to identify all possible rules that might be needed for other decisions. F. and G. There is no one answer to these parts. Sample solutions and a discussion of typical student responses will be included in assessment guidance on the Instructor’s web site for the textbook (available at www.wiley.com/college/eldenburg).
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Use of Joint Cost Information; Strategic
This is an open ended question. Student answers will differ based on their choice of products or business. The answer must be in memo format addressed to the professor. Students must include the following information: A. An example of how joint cost information could inappropriately affect decision making and the example must be supported by references to actual products or business. B. An example of how joint cost information could improve decision making and the example must be supported by references to actual products or business. C. A strategy, and a description of how it could be implemented, to prevent the misuse of cost accounting information and explain how cost accounting information should be used to support strategic objectives. 9.45
Integrating Across the Curriculum–Economics and Governmental Regulation – Canadian Beef Industry
A. Canadian beef by-products might end up in landfills unless some alternative use can be identified. B. 1. The cost of main products would probably increase because of the loss in revenue from by-product sales and also because of increased waste disposal costs. 2. The ban would probably increase the cost of main products in other livestock industries. Currently, beef by-products are used as feed in these industries. Other sources of feed must currently cost more than beef by-products (otherwise, they would currently be used), and an increase in demand would cause the cost to be even higher. C. The ban could have both positive and negative effects. In the short term, the increase in cost would encourage meat producers to increase prices. Consumers might shift their consumption habits to purchase other, less costly sources of meat and protein. Some producers might fail financially. The ban could also have positive effects. In the short term, consumers might shift their consumption away from Canadian beef because of higher cost, negative publicity, and concerns about the long time frame for mad cow disease. But in the long term, the ban might encourage domestic and international consumers to have greater confidence in the quality of Canadian beef, leading to higher prices. D. Below is a brief description of Canadian regulators responsibilities to key stakeholder groups. •
Canadian cattle industry: The regulators are responsible for developing standards and ensuring industry compliance. When developing standards, the regulators must consider their potential effect on the Canadian cattle industry.
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Cost Management This means that regulators must sometimes weigh the social costs and benefits of its regulations against the impact on the industry. •
Other Canadian livestock industries, such as pigs and chicken: Regulators have the same responsibility for other livestock industries that they have for the cattle industry. Their decisions about beef and other mammal by-products will directly affect the well-being of other livestock industries, in addition to that of the cattle industry. Therefore, the regulators have a responsibility to weigh not only the effects of their decisions on the cattle industry but also on the competitor livestock industries.
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Other Canadian food manufacturers: Regulator responsibilities extend to other food manufacturers. Any shift in the type of food permitted for livestock will affect other types of food manufacturers. Thus, the regulators’ responsibilities for other food manufacturers are similar to that for the other livestock industries.
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Consumers of Canadian beef: Because of uncertainties about the source of mad cow disease in this case, the degree of risk to consumers was not clear. In addition, there were uncertainties about whether there were adverse effects from the use of beef by-products for feed to other livestock or from the use of other mammal by-products in cattle feed. These uncertainties made it difficult for regulators to adopt an appropriate policy on behalf of beef consumers. A central part of the regulators’ dilemma was a lack of consensus about the nature of their responsibility to consumers. Some people argued that the regulators were responsible for ensuring absolute consumer safety, which meant that regulators should err on the side of safety in cases of uncertainty. Others argued that the regulators were responsible only for known safety problems and that it was appropriate to weigh cattle industry and other economic factors against the interests of consumers. A further complication was the demand of consumers for low beef prices. Questions were raised about whether consumers would be willing to pay for increased safety.
E. The validity of this argument depends on one’s values and on the uncertainties described in the answer to Part D. The source of the mad cow infection was unknown, and the extent of potential infections throughout the industry was also unknown. Some experts argued that the combined probabilities of mad cow disease and human infection were very low. And, there had been no cases of brain-wasting disease related to the consumption of Canadian beef. Thus, some people argued that no serious risk existed. However, both the cattle and human forms of the disease took many years to develop, and at least some risk existed that problems would become evident in the future. It was also difficult to define an acceptable level of risk. Was it acceptable if only a small number of people were to develop a fatal brain-wasting disease? Or should the target number have been zero? F. There is no single answer to this question. The goal is for students to synthesize the issues addressed in Parts A through E into a cohesive conclusion. Students must also © 2012 John Wiley and Sons Canada, Ltd.
Chapter 9: Joint Product and By-Product Costing make difficult decisions about how factors should be weighed in light of conflicting interests.
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