Approaches to Allocating Joint Costs

Learning Objective 3 Allocate joint costs using four methods

• sales value at splitoff, physical measure, net realizable value (NRV), and constant gross-margin percentage NRV

Two approaches are used to allocate joint costs.

1. • APPROACH 1. Allocate joint costs using market-based data such as revenues. This chapter illustrates three methods that use this approach:
   1. 1. Sales value at splitoff method
   2. 2. Net realizable value (NRV) method
   3. 3. Constant gross-margin percentage NRV method
2. • APPROACH 2. Allocate joint costs using physical measures, such as the weight, quantity (physical units), or volume of the joint products.

The cause-and-effect and benefits-received criteria often guide cost-allocation decisions (see Exhibit 15-2). Joint costs do not have a cause-and-effect relationship with individual products because the production process simultaneously yields multiple products. The benefits-received criterion leads managers to favor methods under approach 1 because revenues are, in general, a better indicator of benefits received than physical measures. Mining companies, for example, receive more benefit from one ton of gold than from 10 tons of coal.

In the simplest joint production process, joint products are sold at the splitoff point without further processing. For this case, Example 1 illustrates two methods: the sales value at splitoff method and the physical-measure method. Sometimes, the joint production process yields products that require further processing beyond the splitoff point. For this case, Example 2 illustrates the NRV method and the constant gross-margin percentage NRV method. To help focus on key concepts, we use numbers and amounts that are smaller than the numbers typically found in practice.

The following symbols distinguish a joint or main product from a byproduct:

How much of the $400,000 joint costs should be allocated to the cost of goods sold of 20,000 gallons of cream and 30,000 gallons of liquid skim, and how much to the ending inventory of 5,000 gallons of cream and 45,000 gallons of liquid skim? We illustrate the sales value at splitoff method and the physical-measure method.

Sales Value at Splitoff Method

The sales value at splitoff method allocates joint costs to joint products produced during the accounting period on the basis of the relative total sales value at the splitoff point. Exhibit 17-3, Panel A, shows how joint costs are allocated to individual products to calculate the cost per gallon of cream and liquid skim for valuing ending inventory. This method uses the sales value of the entire production of the accounting period (25,000 gallons of cream and 75,000 gallons of liquid skim), not just the quantity sold (20,000 gallons of cream and 30,000 gallons of liquid skim). That’s because joint costs were incurred to produce all units, not just the products sold during the current period.^* Exhibit 17-3, Panel B, presents the product-line income statement using the sales value at splitoff method. The gross-margin percentage for each product is 20% because the sales value at splitoff method allocates joint costs to each product in proportion to the sales value of total production (cream: $\$\text{160,000} ÷ \$\text{200,000}= \mathrm{80\%;}$ liquid skim: $\$\text{240,000} ÷ \$\text{300,000}=80\%$). Therefore, the gross-margin percentage for each product manufactured in May 2020 is the same: 20%.^*

The sales value at splitoff method follows the benefits-received criterion of cost allocation: Costs are allocated to products in proportion to their revenue-generating power (their expected revenues). This method requires selling prices for all products at the splitoff point.