Joint products and by-products in process costing

In Process Costing, the processes often produce more than one type of product. The products produced in addition to the main product can be categorized as joint or by-products. Let us understand the difference between joint and by-products with the help of the following table:

Difference between joint product and by-product

This gives us the main idea of what joint products are and how they differ from by-products. The accounting treatment of a joint product is different from a by-product.

Accounting Treatment of Joint Products

The accounting treatment of joint products is easy to understand with the help of the diagram shown below:

Accounting treatment of joint products

Joint Process Costs are the costs that are incurred up to the split-off point. They are sometimes also referred to as Pre-Separation Costs or Common Costs. This includes raw material, labour, and overhead costs. Joint process costs are apportioned to each joint product at the split-off point(as shown in the diagram above).

Now the question is, “how do we apportion these common costs?” This apportionment can be done in three ways which are based on:

  1. Physical Units
  2. Sales Value
  3. Net Realizable Value (NRV)

To better understand these bases of apportionment, consider the example of Jacksons Manufacturing Limited. The company produces three products, A, B and C. The Joint Costs for the previous month were $500,000. The company has the following information relating to the previous month:

ProductABC
Units produced/Sold20,00018,00012,000
Selling Price per unit ($)25.0030.0080.00
Further processing costs ($)100,000240,000160,000

Let us consider the apportionment based on each base turn by turn.

Physical Units – Basis for apportioning joint costs

When the joint costs are apportioned based on physical units, the total joint costs are divided by the total number of units produced and multiplied by the relative production units of A, B and C respectively as follows:

Formula

Physical units - basis for apportioning joint costs

Sales Value – Basis for apportioning joint costs

When the joint costs are apportioned based on Sales Value, the selling price of each unit is multiplied by the number of units sold to calculate the total sales value of each product. Afterwards, the total costs are divided by the total sales value of each product combined and multiplied by each product’s total sales value as follows:

Formula

Sales Value - Basis for apportioning joint costs

Net Realizable Value (NRV) – Basis for apportioning joint costs

When the joint costs are apportioned based on Net Realizable Value, the total costs are divided by the total NRV of all products and multiplied by the specific’s product NRV. The NRV of a product is calculated by deducting the total costs (including further costs) from the Sales Value of that product.

Formula

Net Realizable Value (NRV) - Basis for apportioning joint costs

Accounting Treatment of By-Products

As we discussed earlier, By-products are of less significance than joint products and will not need precise cost allocation. The factors influencing the choice of cost allocation to by-products are:

  • Is the sales value of by-products known at the time of production?
  • Can the by-products be used as an alternative to the main products?
  • Can the by-products be used in another production process?
  • Are there monetary benefits in terms of cost control or sales expansion if we perform separate profit calculations?

Anyhow, the by-products can be valued using the following methods:

Non-Cost Methods

In non-cost methods, the joint cost is not apportioned to the by-products and the by-products can be valued according to any of the following two methods:

  • Other Income: In this method, the sales proceeds from the by-products are recorded in the statement of profit and loss as other income. This method is used when the sales proceeds from the by-products are insignificant or when the inclusion of sales proceeds from the by-products to the sales proceeds from the main products would not affect the total sales materially.
  • Deduct the By-Product Sales Proceeds from Joint Costs: This method is most widely used for the valuation and costing of by-products. In this method, the Sales proceeds from the by-products are deducted from the total joint costs at the split-off point. This effectively reduces the total cost to be apportioned to the joint products. This method is related to the accounting treatment of normal loss.

Cost Methods

Cost methods seek to apportion some common costs to by-products.

  • Replacement Cost Method: This method values the by-products at the cost that will be incurred if we were to replace the by-products.
  • Total Costs less Standard Price of By-products: In this method, the total joint costs are reduced by the standard price of by-products. The standard price may be arbitrarily set or may represent an average price over time. This is done to avoid fluctuations in the value of the by-product. A variance account is set up to record the difference between the standard and actual price.
  • Joint Cost Pro-Rata Method: Joint cost is apportioned to by-products in the same way it is apportioned to joint products (as we discussed above). This method is the least used method in practice.

Example – Costing of by-products

Chemco Limited manufactures different types of chemicals for various businesses. Process 213 produced two joint products Chemical X and Chemical Y and one by-product Chemical Z. The total pre-separation costs amount to $6,000. Management wants to apportion joint costs to by-products based on physical units after deducting the sale proceeds of by-products from the total joint costs. The following information has been provided to you as an accountant for Chemco Limited:

Example - Costing of by-products