What method is most commonly used for allocating joint processing costs to joint products explain?

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How to Allocate Joint Costs
Price Formulation for Joint Products and By-Products
The splitoff method in cost accounting
Other joint costing methods in cost accounting

What are Joint Products and Joint Costs?

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April 22, 2022 April 22, 2022/ Steven Bragg

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

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

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

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

How to Allocate Joint Costs

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

Allocate based on sales value. Add up all production costs through the split-off point, then determine the sales value of all joint products as of the same split-off point, and then assign the costs based on the sales values. If there are any by-products, do not allocate any costs to them; instead, charge the proceeds from their sale against the cost of goods sold. This is the simpler of the two methods.
Allocate based on gross margin. Add up the cost of all processing costs that each joint product incurs after the split-off point, and subtract this amount from the total revenue that each product will eventually earn. This approach requires additional cost accumulation work, but may be the only viable alternative if it is not possible to determine the sale price of each product as of the split-off point (as was the case with the preceding calculation method).

Price Formulation for Joint Products and By-Products

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

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

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

Short-term pricing. Over the short term, it may be necessary to allow extremely low product pricing, even near the total of costs incurred after the split-off point, if market prices do not allow pricing to be increased to a long-term sustainable level.
Long-term pricing. Over the long term, a company must set prices to achieve revenue levels above its total cost of production, or risk bankruptcy.

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

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

April 22, 2022/ Steven Bragg/

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Here are several reasons why:</p>\n<ul class=\"level-one\">\n <li><p class=\"first-para\">The method relates the benefit of production (revenue of sales value at splitoff) to the related expenses.</p>\n </li>\n <li><p class=\"first-para\">No information on separable costs is required.</p>\n </li>\n <li><p class=\"first-para\">The sales value at splitoff may be the best comparison of the products. At that point, you’re making an apples-to-apples comparison.</p>\n </li>\n</ul>\n<p>Sale value at splitoff isn’t affected by other production or costs after splitoff. A product’s sales value after separable costs have been incurred may be very different. If you spend time and money after the splitoff point, you charge a higher price to recover those costs. 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In the real world, different products produce different levels of profit.</p>\n<p>Finally, the physical measure method (allocating cost by the weight, volume, or some other measurement of the product) doesn’t relate revenue to expenses at all. You may find that this method is the least useful.</p>\n<p class=\"Tip\">Many manufacturers make a big array of products. Two classic examples are automobiles and computer printers. Each manufacturer in each industry offers many makes and models in order to reach slightly different buyers, usually through different price points. Some products are “high volume/low margin,” while others are “low volume/high margin.”</p>\n<p>Here’s a food analogy, you can make money selling 3,000 $1 hamburgers per day or 100 $30 filet mignon dinners per night. Same sales revenue.</p>","description":"<p>When cost accounting, you want to select a method to plan and budget for joint costs. Choosing a method helps you know where you stand during joint production. 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When cost accounting, you want to select a method to plan and budget for joint costs. Choosing a method helps you know where you stand during joint production. You can assess if your actual joint costs are on track with your budget. If you’re off track, you can make changes.

The splitoff method in cost accounting

The splitoff point is the point when the costs of two or more products can be separately identified. After splitoff, each product incurs separable (or independent) costs. Allocating joint costs using sales value at splitoff may be the most effective method for planning and budgeting for joint costs. Here are several reasons why:

The method relates the benefit of production (revenue of sales value at splitoff) to the related expenses.
No information on separable costs is required.
The sales value at splitoff may be the best comparison of the products. At that point, you’re making an apples-to-apples comparison.

Sale value at splitoff isn’t affected by other production or costs after splitoff. A product’s sales value after separable costs have been incurred may be very different. If you spend time and money after the splitoff point, you charge a higher price to recover those costs. So it’s fair to say that the sales value at splitoff method is simple, compared with the others.

Other joint costing methods in cost accounting

There’s a possibility that sales values aren’t available at splitoff. The product’s production may not be far enough along to come up with a price. If there’s no price, you can’t compute sales value. In that case, consider a different method.

The next best method may be the net realizable value (NRV) method. The net realizable value method allocates joint costs on the basis of the final sales value less separable costs. Final sales value is simply the price tag — the price paid by the customer. That price is paid after all production costs, whether they are joint costs or separable costs incurred after splitoff.

The NRV method also does a good job of matching the benefit received (final sales value) with the costs incurred (separable costs). The calculation happens at the end of all production. Contrast that with sales value at splitoff. The difference is a matter of timing.

Making a calculation after production ends has some other benefits. The NRV method accounts for all separable costs, regardless of how much higher or lower they are than your plan. NRV also handles any change to the final sales value (price tag) due to a change in market conditions. NPV captures any changes to costs and sale price that might occur as products are produced separately.

The other methods have their challenges. The constant gross margin percentage method assumes that each department has the same level of profitability. The gross margin percentages and total costs (as a percentage of sales) are the same for everything produced. In the real world, different products produce different levels of profit.

Finally, the physical measure method (allocating cost by the weight, volume, or some other measurement of the product) doesn’t relate revenue to expenses at all. You may find that this method is the least useful.

Many manufacturers make a big array of products. Two classic examples are automobiles and computer printers. Each manufacturer in each industry offers many makes and models in order to reach slightly different buyers, usually through different price points. Some products are “high volume/low margin,” while others are “low volume/high margin.”

Here’s a food analogy, you can make money selling 3,000 $1 hamburgers per day or 100 $30 filet mignon dinners per night. Same sales revenue.