Learning Objective 2 Explain why joint costs are allocated to individual products
to calculate cost of goods sold and inventory and for reimbursements under cost-plus contracts and other types of claims
Joint costs are allocated to individual products or services for several purposes:
Computing inventoriable costs and the cost of goods sold for external and internal reporting purposes. Recall from Chapter 9 that absorption costing is required for financial accounting and tax reporting. This necessitates the allocation of joint manufacturing or processing costs to products for calculating ending inventory values.
Analyzing profitability of divisions and evaluating performance of division managers.
Reimbursing companies that have some, but not all, of their products or services reimbursed under cost-plus contracts with, say, a government agency. For example, joint costs of removing multiple organs from a single donor need to be allocated to various organ centers because transplants into Medicare patients are reimbursed on a cost-plus basis. Stringent rules typically specify the way to assign joint costs. That said, fraud in cost-plus defense contracts remains one of the most active areas of litigation under the Federal False Claims Act. A common practice is “cross-charging,” where a contractor shifts joint costs from “fixed-price” defense contracts to cost-plus contracts.*
Regulating the rates or prices of one or more jointly produced products or services, such as in extractive and energy industries, where output prices are regulated to yield a fixed return on a cost basis that includes joint-cost allocations. In telecommunications, firms have some products subject to price regulation (e.g., wireline services) and others that are unregulated (such as wireless services). In this case, joint costs must be allocated to ensure that costs are not transferred from unregulated services to regulated ones.
For any commercial litigation or insurance settlement situation in which the costs of joint products or services are key inputs.