Cost Accounting — Joint Costing: Split-Off Point, Allocation Methods and Sell-or-Process-Further Decisions

Refining crude oil yields gasoline, diesel and kerosene all at once; slaughtering one head of cattle yields sirloin, tenderloin and hide together. Producing several products simultaneously from a single input is joint production. The costs incurred before the products separate (joint costs) cannot, in principle, be attributed to any one product. Yet they must be allocated to set inventory and cost of sales.

1. The split-off point and types of product

Split-off point: the point at which joint products become identifiable as separate products. Costs before split-off are joint costs; costs incurred on individual products after split-off are separable (further processing) costs.
Main products (joint products): joint products with relatively high sales value.
By-products: products whose sales value is very small compared with the main products. They are often accounted for by reducing the cost of the main products.

2. Methods of allocating joint costs

Company WW processes raw materials to obtain 100 kg of product A and 200 kg of product B at the split-off point, with joint costs of ₩6 million. A can be sold at split-off for ₩50,000 per kg, or processed further for another ₩3 million and sold for ₩100,000 per kg. B is sold at split-off for ₩25,000 per kg. WW processes A further.

Joint cost allocation by method (unit: ₩10,000)
Method	Allocation base	Allocated to A	Allocated to B
Physical-measure method	A 100 kg : B 200 kg	200	400
Sales value at split-off method	A 500 : B 500	300	300
Net realizable value method	A (1,000 − 300) = 700 : B 500	350	250
Constant gross-margin percentage method	Equal gross margin for both products	300	300

Net realizable value method

\text{Allocation} = \text{Joint costs} \times \frac{\text{Product's NRV}}{\text{Total NRV}}, \quad \text{NRV} = \text{Final sales value} - \text{Separable costs}

Used when there is no sales value at split-off or further processing is usual. A's NRV is 700 and B's 500, so A is allocated 600 × 7/12 = 350.

A. Calculating the constant gross-margin method

Total revenue is $1{,}000 + 500 = 1{,}500$ and total cost is joint costs of 600 plus separable costs of 300, i.e. 900 (₩10,000). The overall gross margin is 40%. Work back to costs that give both products a 40% margin.

A: total cost $1{,}000 \times 60\% = 600$ → joint cost allocated $600 - 300 = 300$
B: total cost $500 \times 60\% = 300$ → joint cost allocated 300

B. What the choice of method means

When weight has nothing to do with value, the physical-measure method loads costs onto the cheap product and makes it look unprofitable: B receives ₩4 million of cost against ₩5 million of revenue. Methods based on sales value split costs according to each product’s ability to generate revenue, so they are generally more reasonable.

3. Accounting for by-products

By-products are accounted for in one of two ways.

Production method: at production, the by-product’s NRV is recognized as inventory and joint costs are reduced by that amount. It recognizes the inventory’s value and is theoretically superior.
Sales method: net revenue is recognized when the by-product is sold, as other income or a reduction in cost of sales. It is simple, but timing the sales can change profit.

If a by-product C with an NRV of ₩300,000 had also emerged in the example above, the production method would deduct ₩300,000 from the ₩6 million of joint costs and allocate ₩5.7 million to A and B.

4. The decision to process further

Whether to process further is decided by comparing only incremental revenue and incremental cost. Joint costs were already incurred at split-off and do not change whatever is decided, so they are irrelevant costs.

Selling A at split-off brings ₩5 million; processing further and then selling brings ₩10 million. The incremental revenue of ₩5 million exceeds the separable cost of ₩3 million, so processing increases profit by ₩2 million. How much joint cost A was allocated has nothing to do with this judgement.

Check your understanding

Company XX has joint costs of ₩12 million. At split-off it obtains 400 units of product P (sales value ₩20,000 per unit) and 300 units of product Q (₩40,000 per unit). Q can be sold for ₩50,000 per unit after further processing costing ₩2.4 million. What joint costs are allocated to P and Q under the sales value at split-off method? Should Q be processed further?

Sales values at split-off are ₩8 million for P and ₩12 million for Q, ₩20 million in total. P is allocated $1{,}200 \times 800/2{,}000 = 480$ (₩4.8 million) and Q ₩7.2 million. The incremental revenue from processing Q further is $300 \times (5 - 4) = 300$ (₩3 million) against incremental cost of ₩2.4 million, so processing increases profit by ₩600,000. Q should be processed further.

References

Charles Horngren, Srikant Datar and Madhav Rajan, Cost Accounting: A Managerial Emphasis, ch. 16
Ray Garrison, Eric Noreen and Peter Brewer, Managerial Accounting, ch. 12
Korea Accounting Standards Board, K-IFRS 1002 Inventories (joint products and by-products)