Joints costs incur when more than one product is produced using the same resources. Companies can extract several products out of one main ingredient.
Apportioning joint costs can help companies in calculating the correct selling price. Eventually, the decision can impact the company’s long-term profits.
A company can use several methods to apportion joint costs. Accounting for joint costs can be performed with different methods as discussed below.
What are Joint Costs?
A joint cost is a cost that provides benefits to more than one product. In other words, a joint cost can be attributed to more than one product.
Manufacturing and production companies often incur joint costs. For instance, a dairy production facility will use milk as a primary ingredient that will be used in different products and by-products.
The allocation of joint costs can be determined at a point where the company can identify more than one product. That point is called the split-off point of products.
Joint costs before the split-off point are common costs for all products. Thus, the company must identify and allocate these costs to all products or by-products.
Accounting for Joint Costs
Joints costs incur when a company produces more than one product from the main raw material. Joint costs are common in the production industries such as dairy, oil, chemicals, etc.
The company can use several methods to identify and record the joint costs.
Physical Unit Method
This method uses the physical count of products to allocate the joint costs. The company separates costs based on the number of units produced or volume of production in terms of length, volume, or quantity of products.
The identification and allocation of joint costs to by-products should be performed at the split-off point.
Suppose a company ABC produces paints in different varieties. The following data for raw material and other costs is available.
- Raw Material = $ 10,000
- Direct Labor = $ 6,000
- Overhead Costs = $ 5,000
- White = 450 L
- Yellow = 350 L
- Green = 200 L
- Total Production = 1,000 L
The company ABC can allocate these costs to each product using the physical unit method. In this case, the joint cost allocation base will be the volume of production for each product.
|Product||Production||% Of Total Production||Material Cost %||Labor Cost %||Overhead Cost %||Total Physical Unit Method|
Average Unit Cost Method
In this simple joint cost allocation method, the total cost of production of all units is divided on average to all products. It considers the average cost allocation basis for all products.
The average cost unit may be an appropriate method for production facilities where the products have similar features. For products with discrete ingredients and unique features, this method may not be appropriate.
Continuing with our example above, if we use the same data and apply the average cost method, the result can be calculated as below.
Total Costs = Raw Material + Direct Labor + Overheads
Total Costs = 10,000 + 6,000 + 5,000 = 21,000
Total Production = 450 + 350 + 200 = 1,000
Average Cost = 21,000 / 1,000 = $ 21
|Product||Production||Average Cost||Apportioned Cost|
Contribution Margin Method
The contribution margin method follows the marginal costing method. It considers only variable costs to be apportioned across different products.
It calculated the contribution margin of each product. The profit is then calculated by distributing the fixed costs in the same proportion as the variable costs.
Suppose a company ABC produces dairy products. We consider milk and butter as two products for the example. The following data is available.
- Total Joint Costs = $ 80,000
- Joint Fixed Costs = $ 30,000
- Joint Variable Costs = $ 50,000
- Production: Milk = 10,000 L, Butter = 4,000 L
- Selling Prices: Milk = $ 8, Butter = $ 15
We can apportion joint costs using the contribution margin method as below.
Average variable cost = Joint Variable Cost / Joint Production
Average variable cost = 50,000 / 14,000 = $ 3.58 per liter
|Product||Sales||V. Cost||Contribution Margin||F. Cost apportioned||Profit|
Net Realizable Value Method
The net realizable value (NRV) method considers costs beyond the split-off point as well. Thus, for products that incur large costs after the split 0ff, the NRV method is a suitable option.
The NRV method first calculates the apportioned profits and then apportions the joint costs accordingly. It also considers subsequent costs that incur after the split-off point.
Continuing with our example above for the ABC dairy production facility. We assume that it produces three items; milk, butter, and cheese with a total cost of $ 80,000 before the split-off point.
Further, the following data is available.
Estimated Subsequent Costs:
|Labor||$ 15,000||$ 8,000||$ 6,000|
|Overheads||$ 5,000||$ 3,000||$ 2,000|
|Total||$ 20,000||$ 11,000||$ 8,000|
|Sales Value||$ 80,000||$ 60,000||$ 40,000|
|Estimated Profit %||20||25||50|
|Estimated Profit $||$ 16,000||$ 15,000||$ 20,000|
|Estimated Costs||$ 54,000||$ 45,000||$ 20,000|
|Subsequent Costs Table 01||$ 20,000||$ 11,000||$ 8,000|
|Joint Costs (Apportioned)||$ 34,000||$ 34,000||$ 12,000|
Accounting for joint costs can be performed in several ways. It is a useful concept to allocate joint costs to different products that are produced together.
Some calculations consider costs after the split-off point such as the NRV method. Conventional costing methods such as marginal costing consider the variable costs as a basis to apportion the joint costs.
A company may choose an appropriate method depending on the input information. However, it must consistently follow the same method throughout the accounting cycle.