Chapter 8

ACCOUNTING FOR JOINT AND BY-PRODUCTS

Introduction:

Almost every company produces and sells more than one type of product.
Although companies may engage in multiple production processes to manufacture a
variety of products, they may also engage in a single process to simultaneously
generate various different outputs. For example, the refining of crude oil may produce
gasoline, motor oil, heating oil, and kerosene. A single process in which one product
cannot be manufactured without producing others is known as a joint process. Such
processes are common in the extractive, agricultural, food, and chemical industries.

The costs incurred for materials, labor, and overhead during a joint process
are referred to as the joint cost of the production process. This chapter discusses
joint processes, their related product outputs, and the accounting treatment of joint
cost. Outputs of a joint process are classified based on their revenue-generating
ability, and joint cost is allocated only to the primary products of a joint process, using
either a physical or monetary measure.

Learning objectives:

 Explain the concept of joint cost, joint product, and by-product.

 Discuss the concept of cost allocation in a joint production process.
 Apply the procedures in accounting for joint costs and by-products.

Lesson 1: Joint Process and Its Outputs

A joint process simultaneously produces more than one product line. The
product categories resulting from a joint process that have a sales value are referred
to as (1) joint products, (2) by-products, and (3) scrap.

 Joint products are the primary outputs of a joint process; each joint product
individually has substantial revenue-generating ability. Joint products are the
primary reason management undertakes the production process yielding
them. These products are also called primary products, main products, or co-
 products. Joint products do not necessarily have to be totally different
products; the definition of joint products has been extended to include similar
products of differing quality that result from the same process.
 By-products and scrap are incidental outputs of a joint process. Both are
salable, but their sales values alone would not be sufficient for management
to justify undertaking the joint process. For example, donut hole cutouts are a
by-product of the donut-making process. Scrap may be generated in the
setup stage. By-products are viewed as having a higher sales value than
scrap.
 A final output from a joint process is waste, which is a residual output that
has no sales value. A normal amount of waste may create a production cost
that cannot be avoided in some industries. Alternatively, many companies
have learned either to minimize their production waste by changing their
processing techniques or to reclassify waste as a by-product or scrap through
selling it to generate some minimal amount of revenue.
 A company may change a product classification over time because of
changes in technology, consumer demand, or ecological factors. Some
products originally classified as by-products are reclassified as joint products,
whereas some joint products are reduced to the by-product category. Even
products originally viewed as scrap or waste may be upgraded to a joint
product status. Classification of joint process output is based on the judgment
of company managers, normally after considering the relative sales values of
the outputs. Classifications are unique to each company engaged in the joint
process.

The Split-off Point

The point at which joint process outputs are first identifiable as individual
products is called the split-off point. A joint process may have one or more split-
off points, depending on the number and types of output produced. Output may
be sold at the split-off point if a market exists for products in that condition.
Alternatively, some or all of the products may be processed further after exiting
the joint process.

Joint cost includes all costs incurred up to the split-off point for direct material,
direct labor, and overhead. Joint cost is allocated, at the split-off point, to only the
joint products because these products are the reason that management
 undertook the production process. Allocation is necessary because of the cost
principle. Joint cost is a necessary and reasonable cost of producing the joint
products and, therefore, should be attached to them. Additional costs incurred
after the split-off point that can be identified directly with individual products are
called additional processing costs or separable costs.

Lesson 2 – Methods of Allocating Joint Costs to Joint Products

Joint cost is only assigned to joint products. However, before allocation, joint cost
may be reduced by the value of the by-products and scrap. The most commonly
used methods to allocate joint costs to joint products are:

1. The Physical Measure

2. The Sales Value (Sales Value at Split-off, and
3. The Net Realizable Value method

A. The Physical Measure Method

An easy, objective way to prorate joint cost at the split-off point is
through the use of a physical measure. Physical measurement allocation
treats each unit of output as equally desirable and assigns the same per-unit
cost to each. Physical measures are useful in allocating joint cost to products
that have extremely unstable selling prices.
However, a major disadvantage of allocating joint cost based on a
physical measure is that the method ignores the revenue-generating ability of
individual joint products. Products that weigh the most or that are produced in
the largest quantity will receive the highest proportion of joint cost allocation—
regardless of their ability to bear that cost when they are sold.

Illustration:

Assume the following data for a

manufacturing company: X
Products
X Y Z Total
Unit sales
price P400 P600 P700

Unit
variable
costs 100 350 500
Budgeted 500 300 200 1000
sales
 price in
units
Budgeted
sales
price in
pesos 180,000 200,000 140,000 520,000
Total
fixed
costs P795,000

Allocation of the joint cost based on physical measure is as follows:

Cost per Ton = Total Joint Cost / Total number of Tons

$5,400,000 / 9,000 tons

Joint Cost per Total per Allocated

Product Ton Ton Cost
Steaks 3800 $600 $2,280,000
Roasts 2400 600 1,440,000
Ground 2800 600 1,680,000
9000 $5,400,000

B. The Sales Value at Split-Off Method

The sales value at split-off allocation assigns joint cost to joint
products based solely on the relative sales values of the products at the split-
off point. Thus, to use this method, all joint products must be marketable at
split-off.
Under this method, the low selling price per ton of ground, relative to
the other joint products, results in a lower allocated cost per ton than resulted
from the physical measure allocation technique. This process uses a
weighting technique based on both quantities produced and selling price of
production.

The allocation of the joint cost based on sales value at split-off is shown
below:

Total
Approximated Appoximated
Joint Net Realizable Net Realizable Decimal Amount Cost per
Products Tons Value per Ton Value Fraction Joint Cost Allocated Ton

Steaks 3,800 2,800 10,640,000 0.58 5,400,000 3,132,000 824.21

Roasts 2,400 1,800 4,320,000 0.24 5,400,000 1,296,000 540.00
Ground 2,800 1,200 3,360,000 0.18 5,400,000 972,000 347.14
Total 9,000 18,320,000 1.00 5,400,000
 C. The Net Realizable Value Method
The net realizable value at split-off allocation method assigns joint
cost based on the joint products’ proportional net realizable values at the
point of split-off. Net realizable value (NRV) is equal to product sales revenue
at split-off minus any costs necessary to prepare and dispose of the product.
This method requires that all joint products be marketable at the split-off point,
and it considers the additional costs that must be incurred at split-off to realize
the estimated sales revenue.

The allocation of joint costs using the net realizable value method is as
follows:

Lesson 3 – Accounting for By-Products

The objective in accounting for by-products is to reflect the economic

relationship between the by-products and the main products. The two common
methods used are:

Method 1 – The net realizable value from sale of the by-products is deducted
from the cost of the main product.

Method 2 – The net realizable value from sale of the by-product is treated as
other income.

To illustrate, assume that GS Company has a production process that yields product
ABC as the main product and product X as the by-product. Data related to these
products follow:

ABC X
Sales Value 2,000,000 11,000
Processing costs up to split-off point, chargeable
 To product ABC 800,000
Additional processing costs of product X 3,000

Method 1 Method 2
Sales revenue from ABC P2,000,000 P2,000,000
Other Income (11,000 – 3,000) 0 8,000
Total revenue 2,000,000 2,008,000
Cost of Sales:
Total production costs 800,000 800,000
Less by-product:
Net Realizable Value of X 8,000 0
Adjusted cost of sales 792,000 800,000
Gross margin P1,208,000 P1,208,000

Journal Entries Under each method

Method 1 – The net realizable value of the by-product is deducted from the cost of
the main product.

Work in Process Inventory 800,000

Direct materials inventory
Direct labor 800,000
Manufacturing overhead
*Credits to these accounts assumed for illustrative
purposes

Separable By-product costs 3,000

Direct labor 3,000
Manufacturing overhead
*Credits to these accounts assumed for illustrative
purposes

Accounts Receivable or Cash 11,000

By-product revenue 11,000
*Debit assumed

By-product revenue 11,000

Separable By-product costs 3,000
Work in process inventory 8,000
To deduct the net realizable value of the by-product from
the cost of the main product

Finished Goods Inventory 792,000

Work in process 792,000

Cost of goods sold 792,000

Finished goods inventory 792,000
 2,000,00
Accounts Receivable 0
2,000,00
Sales revenue (Main Product) 0
*Debit assumed
Method 2 – The net realizable value of the by-product is shown as other income in
the Income Statement.

Work in Process Inventory 800,000

Direct materials inventory
Direct labor 800,000
Manufacturing overhead
*Credits to these accounts assumed for illustrative
purposes

Separable By-product costs 3,000

Direct labor 3,000
Manufacturing overhead
*Credits to these accounts assumed for illustrative
purposes

Accounts Receivable or Cash 11,000

By-product revenue 11,000
*Debit assumed

Finished Goods Inventory 800,000

Work in process 800,000

Cost of goods sold 800,000

Finished goods inventory 800,000

2,000,00
Accounts Receivable 0
2,000,00
Sales revenue (Main Product) 0
*Debit assumed

CHAPTER EXRCISES

I – Review Questions:

1. What is joint process? Joint costs?

2. What are the outputs of a joint process?
3. Distinguish between joint product and by-product.
4. What is the objective of joint cost allocation?
 5. Explain the basic difference between the method of accounting for joint
products and that for by-products.

II – Problems

1. A company processes Chemical XD-1 through a pressure treatment

operation. After the process is complete, there are two outputs: R and S. The
monthly cost of processing XD-1 are P45,000 for materials and P160,000 for
conversion costs. This processing results in outputs that sell for a total of
P455,000. The sales revenue from R amounts to P273,000 of the total.
Required:
Compute the costs to be assigned to R and S in a typical month, using the net
realizable value method.

2. BL Company produces only two products and incurs joint processing costs
that total $3,750. Products Aba and Ibi are produced in the following
quantities during each month: 4,500 and 6,000 gallons, respectively. BL also
runs one ad each month that advertises both products at a cost of $1,500.
The selling price per gallon for the two products are $20 and $17.50,
respectively.
Required:
a. What amount of joint processing costs is allocated to each product
based on gallons produced?
b. What amount of advertising cost is allocated to each product based on
sales value?

3. GAB Company produces three products from the same process and incurs
joint processing costs of $3,000.

Disposal
Sales price cost per Further Final sales
per gallon gallon at processing price per
Gallons at split-off split-off costs gallon
Mat 2,300 $ 4.50 $1.25 $1.00 $ 7.00
Nat 1,100 6.00 3.00 2.00 10.00
Qat 500 10.00 8.00 2.00 15.00

Disposal costs for the products if they are processed further are:

Mat, $3.00; Nat, $5.50; Qat, $1.00.

Required:
 a. What amount of joint processing cost is allocated to the three products
using sales value at split-off?
b. What amount of joint processing cost is allocated to the three products
using net realizable value at split-off?

4. A company engages in a manufacturing process that uses one input product

(Q) to produce three outputs (X, P, and Z). outputs X and P are considered
main products and output Z is by-product. During the recent month, the
following events occurred:
1) Produced and sold 200 units of X and 100 units of P. produced 25
units of Z.
2) Recorded sales revenue of P35,000 from sales of X and P. The cost
of sales before accounting for the by-product was P18,000.
3) Incurred P125 to process the 25 units of Z to completion. These costs
are charged as they are incurred against any by products’ sales.
(None of these by-product costs are kept in inventory at the end of the
period.)
4) Received P570 in revenue from the sale of 10 units of Z.

Required:
1) Prepare a statement showing, in parallel columns, the sales revenue,
other income, costs of goods sold, separate costs to process by-
products, and gross margin that would be reported for each of the two
methods.
2) Prepare journal entries under the two methods of accounting for by-
products.