Joint Product Costing Methods for the CPA BAR Exam
Master joint product costing for the CPA BAR section. Covers the split-off point, allocation methods, by-product accounting, and sell-or-process-further decisions.
Understanding Joint Products
Joint products are two or more products that are produced simultaneously from a common input or process. The point at which the products become separately identifiable is called the split-off point. Costs incurred before the split-off point are called joint costs and must be allocated among the joint products. After the split-off point, each product may be sold immediately or processed further into a more refined product.
Joint production is common in many industries: petroleum refining produces gasoline, diesel, kerosene, and other fuels; meat processing yields various cuts plus hides and by-products; lumber milling produces different grades of lumber from a single log; and chemical manufacturing often produces multiple outputs from a single process.
Joint Cost Allocation Methods
Physical Measure Method
The physical measure method allocates joint costs based on a physical measure of output at the split-off point, such as weight, volume, or quantity. For example, if a process yields 6,000 pounds of Product A and 4,000 pounds of Product B from $100,000 in joint costs, Product A receives 60% ($60,000) and Product B receives 40% ($40,000).
This method is simple but often criticized because it ignores the revenue-generating ability of the products. A product that constitutes a large portion of physical output but generates little revenue would be allocated a large share of joint costs, potentially making it appear unprofitable even though the joint process would be undertaken regardless.
Sales Value at Split-Off Method
This method allocates joint costs based on the relative sales value of each product at the split-off point. If Product A has a sales value of $150,000 at split-off and Product B has a sales value of $50,000, the total sales value is $200,000. Product A receives 75% of joint costs and Product B receives 25%. This method is generally preferred when sales values at split-off are available because it reflects the revenue-generating ability of each product.
Net Realizable Value (NRV) Method
When products cannot be sold at the split-off point and must be processed further, the net realizable value method is used. NRV equals the final sales value minus any separable processing costs incurred after the split-off point. Joint costs are allocated based on relative NRV. If Product A has a final sales value of $200,000 with $30,000 in further processing costs (NRV = $170,000) and Product B has a final sales value of $120,000 with $20,000 in further processing costs (NRV = $100,000), joint costs are allocated in the ratio 170:100.
Constant Gross Margin Percentage Method
This method allocates joint costs so that each product earns the same gross margin percentage. First, calculate the overall gross margin percentage for all products combined. Then, for each product, subtract the gross margin from revenue to determine total cost, and subtract separable costs to determine the joint cost allocation. This method ensures uniform profitability across products but can result in negative joint cost allocations in some situations.
By-Products and Scrap
A by-product is a secondary product with relatively minor sales value compared to the main (joint) products. Two common accounting approaches exist for by-products. Under the production method, the NRV of the by-product is recognized at the time of production and reduces the joint cost allocated to the main products. Under the sales method, by-product revenue is recognized when the by-product is sold, typically as other revenue or as a reduction of cost of goods sold.
Scrap is residual material with minimal or no value. If scrap has some sales value, it is typically accounted for similarly to by-products. If it has no value, no special accounting treatment is required.
Sell-or-Process-Further Decisions
One of the most important applications of joint costing concepts is the sell-or-process-further decision. The key principle is that joint costs are irrelevant to this decision because they are sunk costs that will be incurred regardless of what happens after the split-off point.
A product should be processed further only if the incremental revenue from further processing exceeds the incremental cost. If Product A can be sold at split-off for $50,000 or processed further for an additional $15,000 to generate a final sales price of $72,000, the incremental revenue is $22,000 ($72,000 − $50,000) and the incremental cost is $15,000. Since incremental revenue exceeds incremental cost by $7,000, the company should process further.
Joint Costing and Decision Making
It is essential to understand that joint cost allocations are necessary for inventory valuation and financial reporting under GAAP, but they should not be used for decision-making purposes. The allocation is arbitrary to some degree regardless of the method chosen, and no allocation method changes the underlying economics of the joint process. Decisions about whether to undertake the joint process should be based on whether total revenues exceed total costs, not on the profitability of individual products after allocation.
Exam Preparation Tips
- Know all four joint cost allocation methods and when each is appropriate.
- Understand the difference between joint costs and separable costs.
- Be able to perform sell-or-process-further analysis, remembering that joint costs are irrelevant.
- Know the two methods for accounting for by-products.
- Remember that joint cost allocations are necessary for GAAP reporting but should not drive decision making.
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