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costacctg13_sm_ch16 - CHAPTER 16 COST ALLOCATION JOINT...

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Unformatted text preview: CHAPTER 16 COST ALLOCATION: JOINT PRODUCTS AND BYPRODUCTS 16­1 Exhibit 16­1 presents many examples of jo int products from four different general industries. These include: Industry Separable Products at the Splitoff Point Food Processing: • Lamb • Lamb cuts, tripe, hides, bones, fat • Turkey • Breasts, wings, thighs, poultry meal Extractive: • Petroleum • Crude oil, natural gas 16­2 A joint cost is a cost of a production process that yields mult iple products simultaneously. A separable cost is a cost incurred beyo nd the splitoff po int that is assignable to each of the specific products ident ified at the splito ff po int. 16­3 The dist inct ion between a jo int product and a byproduct is based on relat ive sales value. A joint product is a product from a jo int production process (a process that yields two or more products) that has a relatively high total sales value. A byproduct is a product that has a relat ively low total sales value compared to the total sales value of the jo int (or main) products. 16­4 A product is any output that has a posit ive sales value (or an output that enables a company to avoid incurr ing costs). In some jo int­cost settings, outputs can occur that do not have a posit ive sales value. The offshore processing o f hydrocarbons yields water that is recycled back into the ocean as well as yielding oil and gas. The processing of mineral ore to yield gold and silver also yields dirt as an output, which is recycled back into the ground. 16­5 The chapter lists the fo llowing six reasons for allocating jo int costs: 1. Computation o f inventoriable costs and cost of goods sold for financial account ing purposes and reports for inco me tax authorit ies. 2. Computation of inventoriable costs and cost of goods sold for internal reporting purposes. 3. Cost reimbursement under contracts when only a portion of a business's products or services is so ld or delivered under cost­plus contracts. 4. Insurance settlement computations for damage claims made on the basis o f cost informat ion of jo int products or byproducts. 5. Rate regulat ion when one or more of the jo int ly­produced products or services are subject to price regulat ion. 6. Lit igat ion in which costs of jo int products are key inputs. 16­6 The jo int production process yields individual products that are either so ld this period or held as inventory to be sold in subsequent periods. Hence, the jo int costs need to be allocated between total production rather than just those sold this period. 16­7 This situat ion can occur when a production process yields separable outputs at the splito ff point that do not have selling prices available until further processing. The result is that selling prices are not available at the splitoff po int to use the sales value at splitoff method. Examples include processing in integrated pulp and paper companies and in petro­chemical operations. 16­1 16­8 Both methods use market selling­price data in allocat ing jo int costs, but they differ in which sales­price data they use. The sales value at splitoff method allocates jo int costs to jo int products on the basis o f the relat ive total sales value at the splito ff po int of the total production of these products during the account ing period. The net realizable value method allocates jo int costs to jo int products on the basis o f the relat ive net realizable value (the final sales value minus the separable costs of production and marketing) of the total production of the jo int products during the accounting period. 16­9 Limitat ions of the physical measure method of jo int­cost allocat ion include: a. The physical weights used for allocating jo int costs may have no relat ionship to the revenue­producing power of the individual products. b. The jo int products may not have a commo n phys ical deno minator––for example, one may be a liquid while another a solid with no readily available conversio n factor. 16­10 The NRV method can be simplified by assuming (a) a standard set of post­splitoff point processing steps, and (b) a standard set of selling prices. The use of (a) and (b) achieves the same benefits that the use of standard costs does in costing systems. 16­11 The constant gross­margin percentage NRV method takes account of the post­splito ff point “profit” contribution earned on individual products, as well as jo int costs, when making cost assignments to joint products. In contrast, the sales value at splito ff po int and the NRV methods allocate only the jo int costs to the individual products. 16­12 No. Any method used to allocate jo int costs to individual products that is applicable to the problem of jo int product­cost allo cat ion should not be used for management decisio ns regarding whether a product should be so ld or processed further. When a product is an inherent result of a jo int process, the decisio n to process further should not be influenced by either the size of the total jo int costs or by the portion of the jo int costs assigned to particular products. Joint costs are irrelevant for these decis io ns. The only relevant items for these decisio ns are the incremental revenue and the incremental costs beyond the splito ff po int. 16­13 No. The only relevant items are incremental revenues and incremental costs when making decisio ns about selling products at the splitoff po int or processing them further. Separable costs are not always identical to incremental costs. Separable costs are costs incurred beyo nd the splitoff po int that are assignable to individual products. Some separable costs ma y not be incremental costs in a specific setting (e.g., allocated manufacturing overhead for post­ splito ff processing that includes depreciat ion). 16­14 Two methods to account for byproducts are: a. Production method—recognizes byproducts in the financial statements at the time production is co mpleted. b. Sales method—delays recognit io n of byproducts unt il the t ime of sale. 16­15 The sales byproduct method enables a manager to time the sale of byproducts to affect reported operating inco me. A manager who was below the targeted operating inco me could adopt a “fire­sale” approach to selling byproducts so that the reported operating inco me exceeds the target. This illustrates one dysfunctional aspect of the sales method for byproducts. 16­2 16­16 (20­30 min.) Joint­cost allocation, insurance settlement. 1. (a) Sales value at splitoff method: Pounds of Product 100 20 40 80 10 250 Wholesale Sales Weighting: Joint Selling Price Value Sales Value Costs per Pound at Splitoff at Splitoff Allocated $0.55 $55.00 0.675 $33.75 0.20 4.00 0.049 2.45 0.35 14.00 0.172 8.60 0.10 8.00 0.098 4.90 0.05 0.50 0.006 0.30 $81.50 1.000 $50.00 Allocated Costs per Pound 0.3375 0.1225 0.2150 0.0613 0.0300 Breasts Wings Thighs Bones Feathers Costs of Destroyed Product Breasts: $0.3375 per pound ´ 40 pounds = $13.50 Wings: $0.1225 per pound ´ 15 pounds = 1.84 $15.34 b. Physical measure method: Pounds of Product 100 20 40 80 10 250 Weighting: Physical Measures 0.400 0.080 0.160 0.320 0.040 1.000 Joint Costs Allocated $20.00 4.00 8.00 16.00 2.00 $50.00 Allocated Costs per Pound $0.200 0.200 0.200 0.200 0.200 Breasts Wings Thighs Bones Feathers Costs of Destroyed Product Breast: $0.20 per pound ´ 40 pounds Wings: $0.20 per pound ´ 15 pounds = = $ 8 3 $11 Note: Alt hough not required, it is useful to highlight the individual product profitabilit y figures: Sales Value at Splitoff Method Joint Costs Gross Allocated Income $33.75 $21.25 2.45 1.55 8.60 5.40 4.90 3.10 0.30 0.20 Physical Measures Method Joint Costs Gross Allocated Income $20.00 $35.00 4.00 0.00 8.00 6.00 16.00 (8.00) 2.00 (1.50) Product Breasts Wings Thighs Bones Feathers Sales Value $55.00 4.00 14.00 8.00 0.50 16­3 2. The sales­value at splitoff method captures the benefits­received criterion of cost allocat ion and is the preferred method. The costs of processing a chicken are allocated to products in proportion to the abilit y to contribute revenue. Qualit y Chicken’s decisio n to process chicken is heavily influenced by the revenues fro m breasts and thighs. The bones provide relat ively few benefits to Qualit y Chicken despite their high physical vo lume. The physical measures method shows profits on breasts and thighs and losses on bones and feathers. Given that Qualit y Chicken has to joint ly process all the chicken products, it is non­ intuit ive to single out individual products that are being processed simultaneously as making losses while the overall operations make a profit. Qualit y Chicken is processing chicken mainly for breasts and thighs and not for wings, bones, and feathers, while the phys ical measure method allocates a disproportionate amount of costs to wings, bones and feathers. 16­17 (10 min.) Joint products and byproducts (continuation of 16­16). 1. Ending inventory: Breasts 15 Wings 4 Thighs 6 Bones 5 Feathers 2 ´ $0.3375 = $5.0625 ´ 0.1225 = 0.4900 ´ 0.2150 = 1.2900 ´ 0.0613 = 0.3065 ´ 0.0300 = 0.0600 $7.2090 Net Realizable Values of byproducts: Wings $ 4.00 Bones 8.00 Feathers 0.50 $12.50 2. Joint products Breasts Thighs Byproducts Wings Bones Feathers Joint costs to be allocated: Joint costs – Net Realizable Values of byproducts = $50 – $12.50 = $37.50 Pounds of Product Wholesale Selling Price per Pound Sales Value at Splitoff Weighting: Sales Value at Splitoff Joint Costs Allocated Allocated Costs Per Pound Breast Thighs 100 40 $0.55 0.35 $55 14 $69 55 ÷ 69 14 ÷ 69 $29.89 7.61 $37.50 $0.2989 0.1903 Ending inventory: Breasts 15 ´ $0.2989 Thighs 6 ´ 0.1903 $4.4835 1.1418 $5.6253 3. Treating all products as jo int products does not require judgments as to whether a product is a jo int product or a byproduct. Joint costs are allocated in a consistent manner to all products for the purpose of costing and inventory valuat ion. In contrast, the approach in requirement 2 lowers the jo int cost by the amount of byproduct net realizable values and results in inventory values being shown for only two of the five products, the ones (perhaps arbitrarily) designated as being jo int products. 16­4 16­18 (10 min.) Net realizable value method. A diagram o f the situation is in Solut ion Exhibit 16­18. Corn Syrup Final sales value of total production, 12,500 ´ $50; 6,250 ´ $25 Deduct separable costs Net realizable value at splito ff po int Weight ing, $250,000; $62,500 ¸ $312,500 Joint costs allocated, 0.8; 0.2 ´ $325,000 $625,000 375,000 $250,000 0.8 $260,000 Corn Starch $156,250 93,750 $ 62,500 0.2 $ 65,000 Total $781,250 468,750 $312,500 $325,000 SOLUTION EXHIBIT 16­18 (all numbers are in thousands) Joint Costs Separable Costs Processing $375,000 Corn Syrup: 12,500 cases at $50 per case Processing $325, 000 Processing $93,750 Corn Starch: 6,250 cases at $25 per case Splitoff P o in t 16­5 16­19 (40 min.) Alternative joint­cost­allocation methods, further­process decision. A diagram o f the situation is in Solut ion Exhibit 16­19. 1. Physical measure of total production (gallo ns) Weight ing, 2,500; 7,500 ¸ 10,000 Joint costs allocated, 0.25; 0.75 ´ $120,000 2. Final sales value of total production, 2,500 ´ $21.00; 7,500 ´ $14.00 Deduct separable costs, 2,500 ´ $3.00; 7,500 ´ $2.00 Net realizable value at splito ff po int Weight ing, $45,000; $90,000 ¸ $135,000 Joint costs allocated, 1/3; 2/3 ´ $120,000 3. a. Physical­measure (gallo ns) method: Revenues Cost of goods sold: Joint costs Separable costs Total cost of goods sold Gross margin b. Estimated net realizable value method: Revenues Cost of goods sold: Joint costs Separable costs Total cost of goods sold Gross margin Methanol $52,500 40,000 7,500 47,500 $ 5,000 Turpentine $105,000 80,000 15,000 95,000 $ 10,000 Total $157,500 120,000 22,500 142,500 $ 15,000 Methanol $52,500 30,000 7,500 37,500 $15,000 Turpentine Total $105,000 $157,500 90,000 15,000 105,000 $ 0 120,000 22,500 142,500 $ 15,000 Methanol 2,500 0.25 $ 30,000 Methanol $ 52,500 7,500 $ 45,000 1/3 $ 40,000 Turpentine Total 7,500 10,000 0.75 $ 90,000 $120,000 Turpentine $105,000 15,000 $ 90,000 2/3 $ 80,000 Total $157,500 22,500 $135,000 $120,000 16­6 4. Alcohol Bev. Turpentine Final sales value of total production, 2,500 ´ $60.00; 7,500 ´ $14.00 Deduct separable costs, (2,500 ´ $12.00) + (0.20 ´ $150,000); 7,500 ´ $2.00 Net realizable value at splito ff po int Weight ing, $90,000; $90,000 ¸ $180,000 Joint costs allocated, 0.5; 0.5 ´ $120,000 $150,000 $105,000 Total $255,000 60,000 $ 90,000 0.50 $ 60,000 15,000 $ 90,000 0.50 $ 60,000 75,000 $180,000 $120,000 An incremental approach demonstrates that the company should use the new process: Incremental revenue, ($60.00 – $21.00) ´ 2,500 $ 97,500 Incremental costs: Added processing, $9.00 ´ 2,500 $22,500 Taxes, (0.20 ´ $60.00) ´ 2,500 30,000 (52,500) Incremental operating inco me from further processing $ 45,000 Proof: Total sales of both products Joint costs Separable costs Cost of goods sold New gross margin Old gross margin Difference in gross margin $255,000 120,000 75,000 195,000 60,000 15,000 $ 45,000 SOLUTION EXHIBIT 16­19 Joint C osts Separable Cos ts 2, 500 ga llons Pro ces sing $3 per gallon Meth anol: 2,50 0 gallons at $21 per gallon Processing $120, 0 00 for 10 ,00 0 gallons 7, 500 ga llons Processin g $2 per gallon Turpentin e: 7, 500 gallon s at $14 per gallon Splitoff P oint 16­7 16­20 (40 min.) Alternative methods of joint­cost allocation, ending inventories. Total production for the year was: Ending Inventories 180 60 25 Total Production 300 400 500 X Y Z 1. Sold 120 340 475 A diagram o f the situation is in Solut ion Exhibit 16­20. a. Net realizable value (NRV) method: X Final sales value of total production, 300 ´ $1,500; 400 ´ $1,000; 500 ´ $700 Deduct separable costs Net realizable value at splito ff po int Weight ing, $450; $400; $150 ¸ $1,000 Joint costs allocated, 0.45, 0.40, 0.15 ´ $400,000 Ending Inventory Percentages: Ending inventory Total production Ending inventory percentage Income Statement X Revenues, 120 ´ $1,500; 340 ´ $1,000; 475 ´ $700 Cost of goods sold: Joint costs allocated Separable costs Production costs Deduct ending inventory, 60%; 15%; 5% of production costs Cost of goods sold Gross margin Gross­margin percentage $180,000 180,000 –– 180,000 108,000 72,000 $108,000 60% Y $340,000 160,000 –– 160,000 24,000 136,000 $204,000 60% Z $332,500 60,000 200,000 260,000 13,000 247,000 $ 85,500 25.71% Total $852,500 400,000 200,000 600,000 145,000 455,000 $397,500 X 180 300 60% Y 60 400 15% Z 25 500 5% $450,000 –– $450,000 0.45 $180,000 Y $400,000 –– $400,000 0.40 $160,000 Z Total $350,000 $1,200,000 200,000 200,000 $150,000 $1,000,000 0.15 $ 60,000 $ 400,000 16­8 b. Constant gross­margin percentage NRV method: Step 1: Final sales value of prodn., (300 ´ $1,500) + (400 ´ $1,000) + (500 ´ $700) Deduct jo int and separable costs, $400,000 + $200,000 Gross margin Gross­margin percentage, $600,000 ÷ $1,200,000 Step 2: X Final sales value of total production, 300 ´ $1,500; 400 ´ $1,000; 500 ´ $700 Deduct gross margin, using overall gross­margin percentage of sales, 50% Total production costs Step 3: Deduct separable costs Joint costs allocated $450,000 225,000 225,000 — $225,000 Y $400,000 200,000 200,000 — $200,000 Z $1,200,000 600,000 $ 600,000 50% Total $350,000 $1,200,000 175,000 175,000 600,000 600,000 200,000 200,000 $(25,000) $ 400,000 The negative jo int­cost allo cat ion to Product Z illustrates one “unusual” feature of the constant gross­margin percentage NRV method: some products may receive negat ive cost allocat ions so that all individual products have the same gross­margin percentage. Income Statement X Revenues, 120 ´ $1,500; 340 ´ $1,000; 475 ´ $700 Cost of goods sold: Joint costs allocated Separable costs Production costs Deduct ending inventory, 60%; 15%; 5% of production costs Cost of goods sold Gross margin Gross­margin percentage $180,000 Y $340,000 Z Total $332,500 $852,500 225,000 ­ 225,000 135,000 90,000 $ 90,000 50% 200,000 ­ 200,000 30,000 170,000 $170,000 50% (25,000) 200,000 175,000 400,000 200,000 600,000 8,750 173,750 166,250 426,250 $166,250 $426,250 50% 50% 16­9 Summary X a. NRV method: Inventories on balance sheet Cost of goods sold on inco me statement $108,000 72,000 Y $ 24,000 136,000 Z Total $ 13,000 $145,000 247,000 455,000 $600,000 b. Constant gross­margin percentage NRV method $135,000 90,000 $ 30,000 170,000 $ 8,750 $173,750 166,250 426,250 $600,000 Inventories on balance sheet Cost of goods sold on inco me statement 2. Gross­margin percentages: X 60% 50% Y 60% 50% Z 25.71% 50.00% NRV method Constant gross­margin percentage NRV SOLUTION EXHIBIT 16­20 Joint Costs Separable Costs Product X: 300 tons at $1,500 per ton J o in t Processing Costs $400, 000 Product Y: 400 tons at $1,000 per ton Processing $200, 000 Splitoff P o in t Product Z: 500 tons at $700 per ton 16­10 16­21 (30 min.) Joint­cost allocation, process further. ICR8 (Non­Saleable) Processing $175 Crude Oil 150 bbls × $18 / bbl = $2,700 Joint Costs = $1, 800 ING4 (Non­Saleable) Processing $105 NGL 50 bbls × $15 / bbl = $750 XGE 3 (Non­Saleable) Splitoff P o in t Processing $210 Gas 800 eqvt bbls × $1.30 / eqvt bbl = $1,040 1a. Physical Measure Method Crude Oil 150 0.15 $270 NGL 50 0.05 $90 Gas 800 0.80 $1,440 Total 1,000 1.00 $1,800 1. Physical measure of total prodn. 2. Weight ing (150; 50; 800 ÷ 1,000) 3. Joint costs allocated (Weights ´ $1,800) 1b. NRV Method 1. 2. 3. 4. 5. Final sales value of total production Deduct separable costs NRV at splitoff Weight ing (2,525; 645; 830 ÷ 4,000) Joint costs allocated (Weights ´ $1,800) Crude Oil $2,700 175 $2,525 0.63125 $1,136.25 NGL $750 105 $645 0.16125 $290.25 Gas $1,040 210 $ 830 0.20750 $373.50 Total $4,490 490 $4,000 $1,800 16­11 2. (a) The operating­inco me amounts for each product using each method is: Physical Measure Method Crude Oil $2,700 270 175 445 $2,255 NGL $750 90 105 195 $555 Gas $1,040 1,440 210 1,650 $ (610) Total $4,490 1,800 490 2,290 $2,200 Revenues Cost of goods sold Joint costs Separable costs Total cost of goods sold Gross margin (b) NRV Method Revenues Cost of goods sold Joint costs Separable costs Total cost of goods sold Gross margin Crude Oil $2,700.00 1,136.25 175.00 1,311.25 $1,388.75 NGL $750.00 290.25 105.00 395.25 $354.75 Gas $1,040.00 373.50 210.00 583.50 $ 456.50 Total $4,490.00 1,800.00 490.00 2,290.00 $2,200.00 3. Neither method should be used for product emphasis decisions. It is inappropriate to use jo int­cost­allocated data to make decisio ns regarding dropping individual products, or pushing individual products, as they are jo int by definit io n. Product­emphasis decisio ns should be made based on relevant revenues and relevant costs. Each method can lead to product emphasis decisio ns that do not lead to maximizat ion of operating income. 4. Since crude o il is the only product subject to taxat ion, it is clearly in Sinclair’s best interest to use the NRV method since it leads to a lower profit for crude oil and, consequent ly, a smaller tax burden. A letter to the taxation authorit ies could stress the conceptual superiorit y o f the NRV method. Chapter 16 argues that, using a benefit s­received cost allocat ion criterion, market­based jo int cost allocat ion methods are preferable to physical­measure methods. A meaningful commo n deno minator (revenues) is available when the sales value at splito ff po int method or NRV method is used. The phys ical­measures method requires nonho mogeneous products (liquids and gases) to be converted to a commo n deno minator. 16­12 16­22 (30 min.) Joint­cost allocation, sales value, physical measure, NRV methods. 1a. PANEL A: Allocation of Joint Costs using Sales Value at Splitoff Method Sales value of total production at splitoff point (10,000 tons ´ $10 per ton; 20,000 ´ $15 per ton) Weighting ($100,000; $300,000 ÷ $400,000) Joint costs allocated (0.25; 0.75 ´ $240,000) PANEL B: Product­Line Income Statement for June 2009 Revenues (12,000 tons ´ $18 per ton; ...
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