Physical-Measure Method

The physical-measure method allocates joint costs to joint products produced during the accounting period on the basis of a comparable physical measure, such as the relative weight, quantity, or volume at the splitoff point. Exhibit 17-4, Panel A, shows how the $400,000 of joint costs are allocated to individual products to calculate the cost per gallon of cream and liquid skim based on the 25,000 gallons of cream and 75,000 gallons of liquid skim produced.

Exhibit 17-4

Joint-Cost Allocation and Product-Line Income Statement Using Physical-Measure Method: Farmland Dairy for May 2020

Spreadsheet screenshot shows the joint-cost allocation and product line income statement using physical-measure method of Farmland dairy for May 2020.

The spreadsheet shows two panels depicting the data for the products cream and liquid skim.

  1. Panel A: Allocation of joint costs using physical-measure method

    1. Physical measure of total production (in gallons)

      • Cream: $25,000

      • Liquid skim: $75,000

      • Total: $100,000

    2. Weighting

      • Cream (25,000 gallons divided by 100,000 gallons): 0.25

      • Liquid skim (75,000 gallons divided by 100,000 gallons): 0. 75

    3. Joint costs allocated

      • Cream (0.25 multiplied by $400,000): $100,000

      • Liquid skim (0.75 multiplied by $400,000): $300,000

      • Total: $400,000

    4. Joint production cost per gallon

      • Cream ($100,000 divided by $25,000 gallons): $4.00

      • Liquid skim ($300,000 divided by 75,000 gallons): $4.00

  2. Panel B: Product-line income statement using physical-measure method for May 2017

    1. Revenues

      • Cream (20,000 gallons multiplied by $8 per gallon): $160,000

      • Liquid skim (30,000 gallons multiplied by $4 per gallon): $120,000

      • Total: $280,000

    2. Costs of goods sold: Production costs of goods sold

      • Cream (0.25 multiplied by $400,000): $100,000

      • Liquid skim (0.75 multiplied by $400,000): $300,000

      • Total: $400,000

    3. Cost of goods sold: Deduct ending inventory

      • Cream (5,000 gallons multiplied by $4 per gallon): $20,000

      • Liquid skim (45,000 gallons multiplied by $4 per gallon): $180,000

      • Total: $200,000

    4. Joint cost of goods sold

      • Cream: $80,000

      • Liquid skim: $120,000

      • Total: $200,000

    5. Gross margin

      • Cream: $80,000

      • Liquid skim: $0

      • Total: $80,000

    6. Gross margin percentage

      • Cream ($80,000 divided by $160,000): 50%

      • Liquid skim ($0 divided by $120,000): 0%

      • Total ($80,000 divided by $280,000): 28.6%

Because the physical-measure method allocates joint costs on the basis of the number of gallons, the cost per gallon is the same for both products. Exhibit 17-4, Panel B, presents the product-line income statement using the physical-measure method. The gross-margin percentages are 50% for cream and 0% for liquid skim.

Under the benefits-received criterion, the physical-measure method is much less desirable than the sales value at splitoff method. Why? Because the physical measures of the individual products may have no relationship to their respective revenue-generating abilities. Consider a mine that extracts ore containing gold, silver, and lead. Using a common physical measure (tons) would result in almost all costs being allocated to lead, the product that weighs the most but has the lowest revenue-generating power. This method of cost allocation is inconsistent with the main reason the mining company is incurring mining costs—to earn revenues from gold and silver, not lead. When using the physical-measure method, products with a high sales value per ton, like gold and silver, show a large “profit,” and products with a low sales value per ton, like lead, show sizable losses.

Obtaining comparable physical measures for all products is not always straightforward. Consider the joint costs of producing oil and natural gas; oil is a liquid and gas is a vapor. To use a physical measure, the oil and gas need to be converted to the energy equivalent for oil and gas, British thermal units.

Managers must decide which products of a joint process to include in a physical-measure computation. Outputs with no sales value (such as dirt in gold mining) are always excluded. Although many more tons of dirt than gold are produced, costs are not incurred to produce zero sales value outputs. Byproducts are also often excluded from the physical-measure computation because of their low sales values relative to the joint products or the main product. The general guideline is to include only the physical measures of joint-product outputs in the weighting computations.

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