Chapter 7 t Product And By-product Costing 6uqy
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CHAPTER 7 t Product and By-Product Costing LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. Identify the characteristics of the t production process. 2. Allocate t product costs according to the benefits-received approaches and the relative market value approaches. 3. Describe methods of ing for by-products. 4. Explain why t cost allocations may be misleading in management decision making. 5. Discuss why t production is seldom found in service industries.
C H A P T E R S U M M A RY This chapter describes the t production processes and their outputs—t products and byproducts. Several methods are developed to allocate t costs to t products. By-products are not usually allocated any of the t costs. Instead, noncost methods are frequently used to for by-products. This chapter concludes with the caution that allocated t costs are not useful for output and pricing decisions. Further processing costs are used in management decision making.
CHAPTER REVIEW I.
General Characteristics of t Production
Learning Objective #1
t products are two or more products produced simultaneously by the same process. t products become separate and identifiable at the split-off point. Review textbook Exhibit 7-1, which depicts the t production process. A.
Cost Separability and the Need for Allocation 1. t costs are the total of the raw material, labor, and overhead costs incurred up to the initial split-off point. a. t costs can be allocated to the final product only in some arbitrary manner because such costs cannot be traced directly to the products they benefit. b. t cost allocation is performed to meet the requirements of financial reporting (GAAP) and federal income tax law for income measurement and inventory 147
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valuation. In addition, t cost allocation is useful in costing for government cost-type contracts and in justifying prices for legislative or istrative regulations. c. t cost allocation is much less useful for cost control and managerial decision making. 2. Separable costs are those costs incurred after the split-off point; they can be easily traced to individual products. B.
Distinction and Similarity Between t Products and By-Products 1. The distinction between t products and by-products rests solely on the relative importance of their sales value. 2. A by-product is a secondary product whose total sales value is relatively minor in comparison with the sales value of the main product (t product). 3. Relationships between t products and by-products change over time as technology and markets change. a. By-products may become more and more important, eventually becoming t products. b. When the relative importance of individual products changes, the products need to be reclassified and the costing procedures need to be changed. Review textbook Exhibit 7-3, which gives examples of t products and by-products for various industries.
II.
ing for t Product Costs A.
Learning Objective #2
Introduction 1. t cost allocations must be done for financial reporting purposes: to value inventory and to determine income. An allocation method must be found, though arbitrary, to allocate the t costs as reasonably as possible. 2. The t cost allocation approaches include the following: a. Benefits-received approaches, which include the following methods:
Physical units method
Weighted average method
b. Allocation based on the relative market value, using the following methods:
B.
Sales-value-at-split-off method
Net realizable value method
Constant gross margin percentage method
Sales-to-production-ratio method
Benefits-Received Approaches 1. Physical Units Method a. Under the physical units method, units of physical output, such as heat content, volume, or weight, that measure the benefits received are used to distribute
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t costs. This method allocates to each t product the same proportion of t costs as the underlying proportion of units. Example: Manufacturers of forest products use the physical units method to apply the average conversion cost to all finished products, regardless of their type, grade, or market value. b. Disadvantages of the physical units method include the following: It ignores the fact that not all costs are directly related to physical quantities. It may result in incorrect managerial decisions because high profit may be reflected from the sale of high-grade products, with low profit or losses reflected from the sale of low-grade products. 2. Weighted Average Method The weighted average method uses the weight factors to include such diverse elements as amount of material used, difficulty to manufacture, time consumed, difference in type of labor used, and size of unit. Weighted physical units = Number of units × Weight factor
Example: The canning industry uses weight factors to distinguish between can sizes or quality of product. The weighted average method allocates relatively more of the t cost to the high-grade products because they represent more desirable and profitable products. C.
Allocation Based on Relative Market Value The methods in this approach try to assign costs based on the product’s ability to absorb t costs. They are based on the assumption that the t costs would not be incurred unless the products yield enough revenues to cover all costs plus a reasonable profit. The relative market value approach of allocation is better than the physical units approach if (1) the physical mix of output can be altered by incurring more (or less) total t costs, and (2) this alteration produces more (or less) total market value. 1. Sales-Value-at-Split-Off Method a. The sales-value-at-split-off method allocates t cost based on each product’s proportionate share of market or sales value at the split-off point. b. In this method, the higher the market value, the greater the t cost assigned to the product. 2. Net Realizable Value Method a. The net realizable value method allocates t costs based on hypothetical sales values because there may not be a ready market for the product at the split-off point. b. This method is particularly useful when one or more products cannot be sold at the split-off point but must be processed further. Hypothetical sales value = Market price – Further processing costs after split-off point
3. Constant Gross Margin Percentage Method
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a. The constant gross margin percentage method allocates t costs such that the gross margin percentage is the same for each product. b. This method assumes that the further processing yields an identical profit percentage across all products. c. Using the constant gross margin percentage method, the t cost allocation steps include the following calculations: Grand gross margin percentage =
(Total revenue – Total costs) Total revenue
t product gross margin = Market price × Grand gross margin t cost allocated to product = Market value – Gross margin – Separable costs
4. Sales-to-Production Ratio a. The sales-to-production-ratio method allocates t costs in accordance with a weighting factor that compares the percentage of sales with the percentage of production. b. In this method, the products that sell the most are allocated a larger share of the t cost of current production. c. Using the sales-to-production-ratio method, the t cost allocation steps include: (1) Compute the percentage of total sales based on the t product units sold. (2) Compute the percentage of total production based on the t product units produced. (3) Compute the sales-to-production ratio of the t product. Sales-to-production ratio =
Percentage of total sales Percentage of production
(4) Use the sales-to-production ratio to allocate t cost. 5. The limitations of allocation based on relative market value include the following: All methods are based on price. If price is used to determine cost, then those costs cannot be used to determine price. The decision would be circular. Changes in relative market prices will cause changes in the costs allocated to the product, even when there has been no change in total costs or the method of production. Using allocation based on relative market value produces the same margin per dollar of allocated cost. This could be misleading to management if the impression is created that all products are equally profitable. Review textbook Exhibit 7-5, which summarizes the t cost allocation methods. III.
ing for By-Products A.
Introduction
Learning Objective #3
t Product and By-Product Costing
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1. The main objective of by-product ing is to determine income and inventory for financial reporting purposes. By-products are of less significance than the main products and may not require precise cost allocation. 2. Relevant factors that influence by-product valuation and ing include: The uncertainty of by-product value at the time of production. The use of the by-product in other production. The use of the by-product as an alternative to main products. The need for separate profit calculations for sales incentives or for control. 3. By-products can be ed for using the following: a. Noncost methods
Other income
By-product revenue deducted from main product cost
b. Cost methods
B.
Replacement cost method
Total costs less by-products valued at standard price method
t cost proration method
Noncost Methods of ing for By-Products Noncost methods make no attempt to allocate t cost to the by-product or its inventory but instead make some credit either to income or to the main product. 1. Other Income Method a. The net sales of by-products for the current period is recognized as “Other Income” or “Miscellaneous Income” and is reported in the income statement. The market value of by-product inventory, if material, should be reported in a footnote to the balance sheet. b. The other income method is used by those firms where:
The value of the by-product is small,
Any other allocation would be more expensive than the benefits received, or Carrying by-products with the main products would not appreciably affect the cost of the main product. c. Disadvantages of this method include the following: Inventories on the balance sheet are misstated since no value is placed on the by-products. Matching of revenues with expenses is improper if production of byproducts occurs in one ing period and sales occur in another. No entry for by-products is made at the time of production, only at the time of sale. No attempt is made to control the inventory of by-products and to prevent them from losses due to fraud or errors. 2. By-Product Revenue Deducted from Main Product Cost
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a. The net sales of by-products will be treated as a deduction from the cost of the main product. Example: The beef-packing industry uses this method because of the great variety of products resulting from operations and the complexity of the processing. b. Disadvantages of this method include the following:
The method tends to understate the value of the main product.
The cost of the main product can vary from month to month because of the varying quantities of by-products sold. C.
Cost Methods of ing for By-Products Cost methods attempt to allocate some t costs to by-products and to carry inventories at the allocated cost levels. 1. Replacement Cost Method The replacement cost method values the by-product inventory at its opportunity cost of purchasing or replacing the by-products. Example: In the oil refining industry, increasing output of one product will cause a reduction in the output and the profit of the other product. 2. Total Costs Less By-Products Valued at Standard Price Method a. By-products are valued at a standard price to avoid fluctuations in by-product value. b. The standard price approach shelters the main product cost from any fluctuations in the by-product price. c. The standard price may be set arbitrarily, or it may reflect an average price over time. d. A variance is used to for the difference between actual and standard prices. 3. t Cost Proration Method The by-product is allocated some portion of the t costs using any one of the t cost allocation methods mentioned in Section II. This method is rarely used in practice.
Review textbook Exhibit 7-5, which summarizes the by-product ing treatments.
IV.
Effect of t Product Costs on Cost Control and Decision Making
Learning Objective #4
t product costing may affect cost control and decision making in the following areas: output decisions, further processing of t products, and pricing tly produced products. A.
Output Decisions 1. Output decisions are normally based on the comparison of total cost of the t products and the combined sales revenues for measuring profitability at any given point.
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2. If management cannot change the product mix or the product mix is determined by customer demand, cost allocation is useless for output decisions because the entire package has to be produced. B.
Further Processing Decisions 1. In making decisions on whether to sell a t product at split-off or to process it further, only the costs and revenues incurred after the split-off point are pertinent. 2. t costs include those costs incurred prior to the split-off point and, thus, are considered sunk costs with respect to further processing decisions (that is, the t cost is not a relevant cost).
C.
Pricing t Products Methods used to set t product prices include: 1. Sales or market price method a. This method maintains a constant relationship of cost to market prices, but it cannot be used to set prices since price has to be known in order to determine cost. b. The method is circular but useful in limited situations. Example: The meat-packing industry uses the market value of byproducts as an important determinant of the main product’s price. Example: The natural gas industry uses it to justify prices and exist ing price relationships to regulatory bodies. t cost allocation is used to determine inventory values, not as a basis to determine a cost to be used in price regulation. 2. Historical market differentials between products method When market differentials are stable over time, this method provides a guide to pricing individual products by giving figures comparable to those of competitors.
D.
Pricing Based on Cost of Further Production This method differs from the benefits-received approaches because it does not assign average cost based on physical or weighted units. It is different from the relative market value because the t product itself does not have a market value. Example: The practice of organ transplant sets the costs of the tly available organs based on the eventual cost of the subsequent transplant operation.
V.
t Production of Services
Learning Objective #5
Normally services do not yield a true t output because a service can be directed to one effect rather than to two effects simultaneously. t cost allocation issues with services usually relate to pricing problems. Example: An insurance company may allow only a portion of a massage therapy charge to be allocated to the therapeutic aspect. Example: The IRS might allow the cost of a two-day seminar as a deductible business expense. But if the seminar were offered on a cruise ship and spread out over a fiveday period, the IRS would look closely if claimed as a deduction and not separated from the overall cost of the cruise.
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KEY TEST From the list that follows, select the term that best completes each statement and write it in the space provided.
net realizable value method noncost methods physical units method replacement cost method sales-to-production-ratio method
sales-value-at-split-off method separable costs split-off point weight factor
1. Costs that are easily traced to individual products are _________________________. 2. The _____________________________________________________ allocates t production costs by comparing the percentage of sales to the percentage of production. 3. The ____________________________________ allocates t production costs based on each product’s share of total units. 4. The _________________________________________________ allocates t production costs based on each product’s share of revenue at the split-off point. 5. The _______________________________________________ allocates t production costs based on the proportionate share of the product’s eventual revenue less further processing costs. 6. A(n) _______________________ tries to incorporate the relative size of products or the difficulty to produce them. 7. _____________________________ make no attempt to cost the by-product or its inventory. 8. The _________________________ is where the t products become separate and identifiable. 9. The _________________________________________ values by-products at the opportunity cost of purchasing or replacing the products.
M U LT I P L E - C H O I C E Q U I Z Complete each of the following statements by circling the letter of the best answer.
1. Which of the following is not an acceptable method of ing for by-products? a. The revenue from the sale of by-products is credited to “Other Income.” b. The by-product is valued at its opportunity costs of purchasing or replacing the product. c. The revenue from the sale of by-products is deducted from the costs of the main products. d. The by-product is valued at a standard price; any fluctuations in the price are isolated in a variance . e. All of the above methods are acceptable approaches to ing for by-products.
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2. Which of the following is a true statement regarding t costs? a. t costs are easily traced to individual products. b. The primary reason for allocating t costs is to determine whether a product should be sold immediately or processed further. c. The primary reason for allocating t costs is for inventory valuation for financial reporting. d. t costs consist only of overhead, never of materials or direct labor. e. None of the above statements are true. 3. Which of the following costs of a t process would be allocated to the t products? a. materials, labor, and overhead b. labor and overhead only c. materials and labor only d. conversion costs less by-product values e. prime costs less by-product values 4. The t cost allocation method that yields the same gross margin percentage for each product is the: a. net realizable value method. b. sales-to-production-ratio method. c. physical units method. d. constant gross margin percentage method. e. sales-value-at-split-off method. 5. The t cost allocation method that assigns t production costs based on the proportionate share of eventual revenues less further processing costs is the: a. net realizable value method. b. sales-to-production-ratio method. c. physical units method. d. constant gross margin percentage method. e. sales-value-at-split-off method. 6. The secondary product recovered in the course of manufacturing a primary product during a t process is: a. a by-product. b. a t product. c. a replacement product. d. a split-off product. e. none of the above. 7. Which of the following t cost allocation methods is not acceptable for financial reporting under generally accepted ing principles? a. net realizable value method b. sales-value-at-split-off method c. physical units method d. constant gross margin percentage method e. All of the methods are acceptable under GAAP.
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Use the following information for Questions 8 through 10:
Allison, Inc., produces two products, X and Y, in a single t process. Last month the t costs were $75,000 when 10,000 units of Product X and 15,000 units of Product Y were produced. Additional processing costs were $15,000 for Product X and $10,000 for Product Y. Product X sells for $10, and Product Y sells for $5. 8. The t cost allocations to Products X and Y using the net realizable value method would be: X
a. b. c. d. e.
Y
$30,000 $45,000 $42,500 $32,500 $42,857 $32,143 $45,000 $30,000 none of the above.
9. The t cost allocations to Products X and Y using the physical units method would be: X
a. b. c. d. e.
Y
$30,000 $45,000 $42,500 $32,500 $42,857 $32,143 $45,000 $30,000 none of the above.
10. The t cost allocations to Products X and Y using the constant gross margin percentage method would be: X
a. b. c. d. e.
Y
$30,000 $45,000 $42,500 $32,500 $42,143 $32,857 $45,000 $30,000 none of the above.
11. Nathan Company produces three products (A, B, and C) in a single t process. All of the products are salable immediately upon split-off. Alternatively, any of the products could be processed further and sold at a higher price. Cost and price information is as follows: Product
Price at Split-Off
A B C
Additional Processing Cost
Price After Processing
Unit Volume
$10,000 25,000 50,000
$12 18 30
10,000 5,000 8,000
$10 15 20
The decision that would maximize profits would be: A
a. b. c. d. e.
sell now process further sell now process further none of the above.
B
C
sell now process further process further sell now
sell now process further sell now process further
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12. Laker Company produces two products along with a single by-product. The t process costs total $200,000. Product A can be sold for $450,000 after additional processing of $250,000; Product B can be sold for $600,000 after additional processing of $200,000. The by-product BP can be sold for $25,000 after packaging costs of $5,000. The by-product is ed for using the by-product revenue deducted from the main product cost approach. What would be the t cost allocation using the net realizable value method? A
a. b. c. d. e.
B
$60,000 $120,000 $66,667 $133,333 $77,143 $102,857 $85,714 $114,286 none of the above
13. Lankip Company produces two main products and a by-product out of a t process. The ratio of output quantities to input quantities of direct material used in the t process remains consistent from month to month. Lankip employs the physical units method to allocate t production costs to the two main products. The net realizable value of the by-product is used to reduce the t production costs before the t costs are allocated to the main products. Data regarding Lankip’s operations for the current month are presented below. During the month, Lankip incurred t production costs of $2,520,000. The main products are not marketable at the split-off point and, thus, have to be processed further. First Main Product
Monthly output in pounds............ Selling price per pound............... Separable process costs............
Second Main Product
90,000 $30 $540,000
By-Product
150,000 $14 $660,000
60,000 $2
The amount of t production cost that Lankip would allocate to the Second Main Product by using the physical units method to allocate t production costs would be: a. $1,200,000. b. $1,260,000. c. $1,500,000. d. $1,575,000. e. $1,650,000. Use the following information for Questions 14 and 15:
Petro-Chem, Inc., is a small company that acquires high-grade crude oil from low-volume production wells owned by individuals and small partnerships. The crude oil is processed in a single refinery into Two Oil, Six Oil, and impure distillates. Petro-Chem does not have the technology or capacity to process these products further and sells most of its output each month to major refineries. There were no beginning inventories for finished goods or work in process on November 1. The production costs and output of Petro-Chem for November are as follows: Crude oil acquired and placed in production........................... Direct labor and related costs.................................................. Factory overhead....................................................................
$5,000,000 2,000,000 3,000,000
Production and sales: Two Oil: 300,000 barrels produced; 80,000 barrels sold at $20 each Six Oil: 240,000 barrels produced; 120,000 barrels sold at $30 each Distillates: 120,000 barrels produced and sold at $15 per barrel
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14. The portion of the t production costs assigned to Six Oil based on physical output would be: a. $3,636,000. b. $3,750,000. c. $1,818,000. d. $7,500,000. e. $4,800,000. 15. The portion of the t production costs assigned to Two Oil based on the relative sales value of output would be: a. $4,800,000. b. $4,000,000. c. $2,286,000. d. $2,500,000. e. $4,445,000.
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PRACTICE TEST EXERCISE 1 Ron Chemicals produces four products from a t process costing $150,000 per month. After leaving the t process, the products must be further refined before they are salable. You have been provided with the following information: Product
A-1 B-3 C-2 Q-9
Volume
15,000 25,000 10,000 50,000
Further Processing Costs
Selling Price per Unit
$350,000 400,000 100,000 250,000
Required:
1. Allocate the t costs using the physical units method.
2. Allocate the t costs using the net realizable value method.
$80 40 22 10
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EXERCISE 2 Bishop Corporation produces three products at a t manufacturing cost of $1,250,000. The following information has been provided: Product
Volume
A B C
25,000 40,000 35,000
Further Processing Costs
$750,000 750,000 210,000
Selling Price per Unit
$40 50 20
Required:
Allocate the t costs using the constant gross margin percentage method.
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EXERCISE 3 Quorum, Inc., has t processing costs of $1,000,000. There are no further processing costs. The demand for Quorum’s products has been fluctuating greatly; production has remained relatively constant. The following information for the past year has been provided: Product
Units Sold
Q-80 R-34 S-99 T-14 U-62
25,000 40,000 35,000 50,000 75,000
Selling Price per Unit
Units Produced
$4.00 5.00 2.00 1.50 3.50
Required:
Allocate the t costs using the sales-to-production-ratio method.
30,000 30,000 50,000 60,000 80,000
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EXERCISE 4 Granite City Monument Works is a manufacturer of cemetery headstones and architectural granite slabs. Granite City excavates blocks of granite from its quarry from its t processes of Quarry and Cutting. Two t products (cemetery monuments and architectural granite) are produced along with a by-product called grit. Cemetery monuments are cut, polished, and engraved in a variety of standard shapes, sizes, and patterns and sold to funeral homes. Architectural granite slabs are special-ordered by contractors for office buildings. These slabs are cut and polished to exacting specifications. The small pieces of granite resulting from the cutting process are crushed and sold to farm-supply outlets as poultry grit. Granite City has provided the following costs and output information: Process
Cost
Tons of Output
Quarry $350,000 100,000 Cutting 250,000 90,000 Monuments 300,000 25,000 Granite slabs 400,000 60,000 Grit 10,000 5,000 Quarry and Cutting are t processes. A local farm-supply distributor purchases all of the grit that is produced at $40 per ton. Assume that Granite City uses the physical units method to allocate t costs. Required:
1. What would be the cost per ton of monuments and granite slabs, assuming that the grit is ed for as “Other Income”?
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EXERCISE 4 (Continued) 2. What would be the cost per ton of monuments and granite slabs, assuming that the grit is ed for as by-product revenue deducted from the main product cost?
EXERCISE 5 Taldot Company produces three products (X, Y, and Z) in a t process costing $100,000. The products can be sold as they leave the process, or they can be processed further and sold. The cost ant has provided you with the following information: Product
Unit Volume
Sales Price at Split-Off
Separable Further Processing Costs
X 3,000 $10 $60,000 Y 4,000 15 50,000 Z 8,000 20 90,000 Assume that all processing costs are variable costs.
Sales Price After Further Processing
$25 30 35
Required:
Which products should Taldot sell at split-off, and which products should be processed further?
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“ C A N YO U ? ” C H E C K L I S T Can you define the t product, split-off point, by-product, and separable costs?
Can you allocate t product costs using a benefits-received approach such as the: physical units method? weighted average method? Can you allocate t product costs using a relative market value approach such as the:
sales-value-at-split-off method? net realizable value method? constant gross margin percentage method? sales-to-production-ratio method?
Can you identify different methods for ing for by-products? Can you explain how to distinguish between a by-product and a main product?
Can you explain t cost allocations related to: output decisions? further processing decisions? pricing of t products? pricing based on the cost of further production? Can you explain how t production costing could be used in a service industry?
ANSWERS KEY TEST 1. 2. 3. 4. 5.
separable costs sales-to-production-ratio method physical units method sales-value-at-split-off method net realizable value method
6. weight factor 7. Noncost methods 8. split-off point 9. replacement cost method
MULTIPLE-CHOICE QUIZ 1. e 2. c 3. a
4. d 5. a 6. a
7. e
t Product and By-Product Costing 8. b
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Net realizable values are computed as follows: X: (10,000 units × $10) – $15,000 = $ 85,000 Y: (15,000 units × $ 5) – $10,000 = 65,000 Total net realizable value = $150,000 t cost allocation ratios are computed using the net realizable value method, and t cost allocation is performed as follows: X: ($85,000 / $150,000) × $75,000 = $42,500 Y: ($65,000 / $150,000) × $75,000 = $32,500
9. a
10. c
t cost allocation ratios are computed using the physical units method, and t cost allocation is performed as follows: X: (10,000 units / 25,000 units) × $75,000 = $30,000 Y: (15,000 units / 25,000 units) × $75,000 = $45,000 t cost allocation ratio is computed using the constant gross margin percentage method as follows: Estimated gross margin = $175,000 – $75,000 – $25,000 = $75,000 Estimated gross margin ratio = $75,000 / $175,000 = 42.857% t cost allocation is computed as follows: X: $100,000 – $15,000 – ($100,000 × 42.857%) = $42,143 Y: $75,000 – $10,000 – ($75,000 × 42.857%) = $32,857
11. d
A: Incremental revenue if processed further = ($12 – $10) × 10,000 units = $20,000 Additional processing cost = $10,000 Conclusion: Process further because the incremental revenue is higher than the incremental costs. B: Incremental revenue if processed further = ($18 – $15) × 5,000 units = $15,000 Additional processing cost = $25,000 Conclusion: Sell immediately because the incremental revenue is lower than the incremental costs. C: Incremental revenue if processed further = ($30 – $20) × 8,000 units = $80,000 Additional processing cost = $50,000 Conclusion: Process further because the incremental revenue is higher than the incremental costs.
12. a
Adjusted t cost after reduction of net sale of by-product = $200,000 – ($25,000 – $5,000) = $180,000 t cost allocation ratios are computed using the net realizable value method as follows: A: $450,000 – $250,000 = $200,000 B: $600,000 – $200,000 = 400,000 Total net realizable value = $600,000 t cost allocation is computed as follows: A: $200,000 / $600,000 × $180,000 = $60,000 B: $400,000 / $600,000 × $180,000 = $120,000
13. c
Total revenue $2,520,000 – By-product net sales (60,000 pounds × $2) = $2,400,000 Allocation ratio for Second Main Product = 150,000 pounds / (90,000 pounds + 150,000 pounds) = 0.625 t cost allocated to Second Main Product = $2,400,000 × 0.625 = $1,500,000
14. a
Total units produced = 300,000 + 240,000 + 120,000 = 660,000 barrels Allocation ratio for Six Oil = 240,000 barrels / 660,000 barrels = 0.3636 t cost allocated to Six Oil = ($5,000,000 + $2,000,000 + $3,000,000) × 0.3636 = $3,636,000
15. b
Two Oil ($20 × 300,000 barrels) = $ 6,000,000 Six Oil ($30 × 240,000 barrels) = 7,200,000 Distillates ($15 × 120,000 barrels) = 1,800,000 Total $15,000,000 Allocation ratio = $6,000,000 / $15,000,000 = 40% t cost allocation = ($5,000,000 + $2,000,000 + $3,000,000) × 40% = $4,000,000
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PRACTICE TEST EXERCISE 1 (Ron Chemicals) 1. Physical Units Method Product: Units............................................................ Allocation %................................................ t cost allocated (% × $150,000)..........
A-1 15,000 15% $22,500
B-3 25,000 25% $37,500
C-2 10,000 10% $15,000
Q-9 50,000 50% $75,000
Total 100,000
A-1 15,000 × $80 $1,200,000 350,000 $ 850,000 46.7% $70,054.95
B-3 25,000 × $40 $1,000,000 400,000 $ 600,000 33.0% $49,450.55
C-2 Q-9 Total 10,000 50,000 × $22 × $10 $220,000 $500,000 100,000 250,000 $120,000 $250,000 $1,820,000 6.6% 13.7% $9,890.11 $20,604.40 $ 150,000
B 40,000 × $50 $2,000,000
C 35,000 × $20 $700,000
$750,000
$210,000
$150,000
2. Net Realizable Value Method Product: Units............................................................ Unit price..................................................... Total revenue............................................... Less: Further processing costs.................. Net realizable value..................................... Allocation %................................................ t cost allocated (% × $150,000)*......... *Differences due to rounding
EXERCISE 2 (Bishop Corporation) Constant Gross Margin Percentage Method Product: A Units............................................................ 25,000 Unit price..................................................... × $40 Revenue...................................................... $1,000,000 Less: t processing cost........................ Less: Separable further processing costs. . $750,000 Gross margin..............................................
Total
$3,700,000) (1,250,000) (1,710,000) $ 740,000)
Gross margin ratio = $740,000 / $3,700,000 = 20% t Cost Allocation Revenue...................................................... $1,000,000) Less: Gross margin at 20%........................ (200,000) Less: Separable further processing costs. . (750,000) t cost allocated..................................... $ 50,000)
$2,000,000) (400,000) (750,000) $ 850,000)
$ 700,000) (140,000) (210,000) $ 350,000)
$3,700,000)
$1,250,000)
EXERCISE 3 (Quorum, Inc.) Sales-to-Production-Ratio Method Product
Q-80 R-34 S-99 T-14 U-62 Total
Units Sold
25,000 40,000 35,000 50,000 75,000 225,000
Percentage of Total Sales
11.11% 17.78% 15.56% 22.22% 33.33%
Units Produced
30,000 30,000 50,000 60,000 80,000 250,000
Percentage of Total Production
Sales-toProduction Ratio
t Cost Allocation Ratio
12.00% 12.00% 20.00% 24.00% 32.00%
0.9259 1.4815 0.7778 0.9259 1.0417 5.1528
17.97% 28.75% 15.09% 17.97% 20.22%
t Cost Allocation
$ 179,695 287,511 150,943 179,695 202,156 $1,000,000
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EXERCISE 4 (Granite City Monument Works) Sales of grit (5,000 tons × $40)............................ Less: Separable costs of processing................... Shown as “Other Income”.....................................
$200,000 10,000 $190,000
1. Grit ed for as “Other Income”: t cost to be allocated = $350,000 Quarry + $250,000 Cutting = $600,000 Product: Tons................................................................ Allocation ratio................................................ t cost allocation (% × $600,000)............. Add: Separable further processing costs....... Total................................................................ Divided by tons............................................... Cost per ton....................................................
Monuments 25,000 29.412% $176,472 300,000 $476,472 ÷ 25,000 $ 19.06
Slabs 60,000 70.588% $423,528 400,000 $823,528 ÷ 60,000 $ 13.73
Total 85,000 $600,000
2. Grit ed for as by-product revenue deducted from main product cost: t cost to be allocated = $350,000 Quarry + $250,000 Cutting – $190,000 By-product net sales = $410,000 Product: Tons................................................................ Allocation ratio................................................ t cost allocation (% × $410,000)............. Less: Separable further processing costs...... Total................................................................ Divided by tons............................................... Cost per ton....................................................
Monuments 25,000 29.412% $120,589 300,000 $420,589 ÷ 25,000 $ 16.82
Slabs 60,000 70.588% $289,411 400,000 $689,411 ÷ 60,000 $ 11.49
Total 85,000 $410,000
EXERCISE 5 (Taldot Company) Product X Y Z
Incremental Revenue if Processed Further $ 45,000 ($25 – $10) × 3,000 60,000 ($30 – $15) × 4,000 120,000 ($35 – $20) × 8,000
Separable Further Processing Costs $60,000 50,000 90,000
Additional Contribution Margin $(15,000) 10,000 30,000
Based on the analysis above, Product X should be sold immediately at the split-off point. Products Y and Z should be processed further and then sold because they can generate more profit if processed further.
C H A P T E R S U M M A RY This chapter describes the t production processes and their outputs—t products and byproducts. Several methods are developed to allocate t costs to t products. By-products are not usually allocated any of the t costs. Instead, noncost methods are frequently used to for by-products. This chapter concludes with the caution that allocated t costs are not useful for output and pricing decisions. Further processing costs are used in management decision making.
CHAPTER REVIEW I.
General Characteristics of t Production
Learning Objective #1
t products are two or more products produced simultaneously by the same process. t products become separate and identifiable at the split-off point. Review textbook Exhibit 7-1, which depicts the t production process. A.
Cost Separability and the Need for Allocation 1. t costs are the total of the raw material, labor, and overhead costs incurred up to the initial split-off point. a. t costs can be allocated to the final product only in some arbitrary manner because such costs cannot be traced directly to the products they benefit. b. t cost allocation is performed to meet the requirements of financial reporting (GAAP) and federal income tax law for income measurement and inventory 147
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valuation. In addition, t cost allocation is useful in costing for government cost-type contracts and in justifying prices for legislative or istrative regulations. c. t cost allocation is much less useful for cost control and managerial decision making. 2. Separable costs are those costs incurred after the split-off point; they can be easily traced to individual products. B.
Distinction and Similarity Between t Products and By-Products 1. The distinction between t products and by-products rests solely on the relative importance of their sales value. 2. A by-product is a secondary product whose total sales value is relatively minor in comparison with the sales value of the main product (t product). 3. Relationships between t products and by-products change over time as technology and markets change. a. By-products may become more and more important, eventually becoming t products. b. When the relative importance of individual products changes, the products need to be reclassified and the costing procedures need to be changed. Review textbook Exhibit 7-3, which gives examples of t products and by-products for various industries.
II.
ing for t Product Costs A.
Learning Objective #2
Introduction 1. t cost allocations must be done for financial reporting purposes: to value inventory and to determine income. An allocation method must be found, though arbitrary, to allocate the t costs as reasonably as possible. 2. The t cost allocation approaches include the following: a. Benefits-received approaches, which include the following methods:
Physical units method
Weighted average method
b. Allocation based on the relative market value, using the following methods:
B.
Sales-value-at-split-off method
Net realizable value method
Constant gross margin percentage method
Sales-to-production-ratio method
Benefits-Received Approaches 1. Physical Units Method a. Under the physical units method, units of physical output, such as heat content, volume, or weight, that measure the benefits received are used to distribute
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t costs. This method allocates to each t product the same proportion of t costs as the underlying proportion of units. Example: Manufacturers of forest products use the physical units method to apply the average conversion cost to all finished products, regardless of their type, grade, or market value. b. Disadvantages of the physical units method include the following: It ignores the fact that not all costs are directly related to physical quantities. It may result in incorrect managerial decisions because high profit may be reflected from the sale of high-grade products, with low profit or losses reflected from the sale of low-grade products. 2. Weighted Average Method The weighted average method uses the weight factors to include such diverse elements as amount of material used, difficulty to manufacture, time consumed, difference in type of labor used, and size of unit. Weighted physical units = Number of units × Weight factor
Example: The canning industry uses weight factors to distinguish between can sizes or quality of product. The weighted average method allocates relatively more of the t cost to the high-grade products because they represent more desirable and profitable products. C.
Allocation Based on Relative Market Value The methods in this approach try to assign costs based on the product’s ability to absorb t costs. They are based on the assumption that the t costs would not be incurred unless the products yield enough revenues to cover all costs plus a reasonable profit. The relative market value approach of allocation is better than the physical units approach if (1) the physical mix of output can be altered by incurring more (or less) total t costs, and (2) this alteration produces more (or less) total market value. 1. Sales-Value-at-Split-Off Method a. The sales-value-at-split-off method allocates t cost based on each product’s proportionate share of market or sales value at the split-off point. b. In this method, the higher the market value, the greater the t cost assigned to the product. 2. Net Realizable Value Method a. The net realizable value method allocates t costs based on hypothetical sales values because there may not be a ready market for the product at the split-off point. b. This method is particularly useful when one or more products cannot be sold at the split-off point but must be processed further. Hypothetical sales value = Market price – Further processing costs after split-off point
3. Constant Gross Margin Percentage Method
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a. The constant gross margin percentage method allocates t costs such that the gross margin percentage is the same for each product. b. This method assumes that the further processing yields an identical profit percentage across all products. c. Using the constant gross margin percentage method, the t cost allocation steps include the following calculations: Grand gross margin percentage =
(Total revenue – Total costs) Total revenue
t product gross margin = Market price × Grand gross margin t cost allocated to product = Market value – Gross margin – Separable costs
4. Sales-to-Production Ratio a. The sales-to-production-ratio method allocates t costs in accordance with a weighting factor that compares the percentage of sales with the percentage of production. b. In this method, the products that sell the most are allocated a larger share of the t cost of current production. c. Using the sales-to-production-ratio method, the t cost allocation steps include: (1) Compute the percentage of total sales based on the t product units sold. (2) Compute the percentage of total production based on the t product units produced. (3) Compute the sales-to-production ratio of the t product. Sales-to-production ratio =
Percentage of total sales Percentage of production
(4) Use the sales-to-production ratio to allocate t cost. 5. The limitations of allocation based on relative market value include the following: All methods are based on price. If price is used to determine cost, then those costs cannot be used to determine price. The decision would be circular. Changes in relative market prices will cause changes in the costs allocated to the product, even when there has been no change in total costs or the method of production. Using allocation based on relative market value produces the same margin per dollar of allocated cost. This could be misleading to management if the impression is created that all products are equally profitable. Review textbook Exhibit 7-5, which summarizes the t cost allocation methods. III.
ing for By-Products A.
Introduction
Learning Objective #3
t Product and By-Product Costing
151
1. The main objective of by-product ing is to determine income and inventory for financial reporting purposes. By-products are of less significance than the main products and may not require precise cost allocation. 2. Relevant factors that influence by-product valuation and ing include: The uncertainty of by-product value at the time of production. The use of the by-product in other production. The use of the by-product as an alternative to main products. The need for separate profit calculations for sales incentives or for control. 3. By-products can be ed for using the following: a. Noncost methods
Other income
By-product revenue deducted from main product cost
b. Cost methods
B.
Replacement cost method
Total costs less by-products valued at standard price method
t cost proration method
Noncost Methods of ing for By-Products Noncost methods make no attempt to allocate t cost to the by-product or its inventory but instead make some credit either to income or to the main product. 1. Other Income Method a. The net sales of by-products for the current period is recognized as “Other Income” or “Miscellaneous Income” and is reported in the income statement. The market value of by-product inventory, if material, should be reported in a footnote to the balance sheet. b. The other income method is used by those firms where:
The value of the by-product is small,
Any other allocation would be more expensive than the benefits received, or Carrying by-products with the main products would not appreciably affect the cost of the main product. c. Disadvantages of this method include the following: Inventories on the balance sheet are misstated since no value is placed on the by-products. Matching of revenues with expenses is improper if production of byproducts occurs in one ing period and sales occur in another. No entry for by-products is made at the time of production, only at the time of sale. No attempt is made to control the inventory of by-products and to prevent them from losses due to fraud or errors. 2. By-Product Revenue Deducted from Main Product Cost
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a. The net sales of by-products will be treated as a deduction from the cost of the main product. Example: The beef-packing industry uses this method because of the great variety of products resulting from operations and the complexity of the processing. b. Disadvantages of this method include the following:
The method tends to understate the value of the main product.
The cost of the main product can vary from month to month because of the varying quantities of by-products sold. C.
Cost Methods of ing for By-Products Cost methods attempt to allocate some t costs to by-products and to carry inventories at the allocated cost levels. 1. Replacement Cost Method The replacement cost method values the by-product inventory at its opportunity cost of purchasing or replacing the by-products. Example: In the oil refining industry, increasing output of one product will cause a reduction in the output and the profit of the other product. 2. Total Costs Less By-Products Valued at Standard Price Method a. By-products are valued at a standard price to avoid fluctuations in by-product value. b. The standard price approach shelters the main product cost from any fluctuations in the by-product price. c. The standard price may be set arbitrarily, or it may reflect an average price over time. d. A variance is used to for the difference between actual and standard prices. 3. t Cost Proration Method The by-product is allocated some portion of the t costs using any one of the t cost allocation methods mentioned in Section II. This method is rarely used in practice.
Review textbook Exhibit 7-5, which summarizes the by-product ing treatments.
IV.
Effect of t Product Costs on Cost Control and Decision Making
Learning Objective #4
t product costing may affect cost control and decision making in the following areas: output decisions, further processing of t products, and pricing tly produced products. A.
Output Decisions 1. Output decisions are normally based on the comparison of total cost of the t products and the combined sales revenues for measuring profitability at any given point.
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2. If management cannot change the product mix or the product mix is determined by customer demand, cost allocation is useless for output decisions because the entire package has to be produced. B.
Further Processing Decisions 1. In making decisions on whether to sell a t product at split-off or to process it further, only the costs and revenues incurred after the split-off point are pertinent. 2. t costs include those costs incurred prior to the split-off point and, thus, are considered sunk costs with respect to further processing decisions (that is, the t cost is not a relevant cost).
C.
Pricing t Products Methods used to set t product prices include: 1. Sales or market price method a. This method maintains a constant relationship of cost to market prices, but it cannot be used to set prices since price has to be known in order to determine cost. b. The method is circular but useful in limited situations. Example: The meat-packing industry uses the market value of byproducts as an important determinant of the main product’s price. Example: The natural gas industry uses it to justify prices and exist ing price relationships to regulatory bodies. t cost allocation is used to determine inventory values, not as a basis to determine a cost to be used in price regulation. 2. Historical market differentials between products method When market differentials are stable over time, this method provides a guide to pricing individual products by giving figures comparable to those of competitors.
D.
Pricing Based on Cost of Further Production This method differs from the benefits-received approaches because it does not assign average cost based on physical or weighted units. It is different from the relative market value because the t product itself does not have a market value. Example: The practice of organ transplant sets the costs of the tly available organs based on the eventual cost of the subsequent transplant operation.
V.
t Production of Services
Learning Objective #5
Normally services do not yield a true t output because a service can be directed to one effect rather than to two effects simultaneously. t cost allocation issues with services usually relate to pricing problems. Example: An insurance company may allow only a portion of a massage therapy charge to be allocated to the therapeutic aspect. Example: The IRS might allow the cost of a two-day seminar as a deductible business expense. But if the seminar were offered on a cruise ship and spread out over a fiveday period, the IRS would look closely if claimed as a deduction and not separated from the overall cost of the cruise.
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KEY TEST From the list that follows, select the term that best completes each statement and write it in the space provided.
net realizable value method noncost methods physical units method replacement cost method sales-to-production-ratio method
sales-value-at-split-off method separable costs split-off point weight factor
1. Costs that are easily traced to individual products are _________________________. 2. The _____________________________________________________ allocates t production costs by comparing the percentage of sales to the percentage of production. 3. The ____________________________________ allocates t production costs based on each product’s share of total units. 4. The _________________________________________________ allocates t production costs based on each product’s share of revenue at the split-off point. 5. The _______________________________________________ allocates t production costs based on the proportionate share of the product’s eventual revenue less further processing costs. 6. A(n) _______________________ tries to incorporate the relative size of products or the difficulty to produce them. 7. _____________________________ make no attempt to cost the by-product or its inventory. 8. The _________________________ is where the t products become separate and identifiable. 9. The _________________________________________ values by-products at the opportunity cost of purchasing or replacing the products.
M U LT I P L E - C H O I C E Q U I Z Complete each of the following statements by circling the letter of the best answer.
1. Which of the following is not an acceptable method of ing for by-products? a. The revenue from the sale of by-products is credited to “Other Income.” b. The by-product is valued at its opportunity costs of purchasing or replacing the product. c. The revenue from the sale of by-products is deducted from the costs of the main products. d. The by-product is valued at a standard price; any fluctuations in the price are isolated in a variance . e. All of the above methods are acceptable approaches to ing for by-products.
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2. Which of the following is a true statement regarding t costs? a. t costs are easily traced to individual products. b. The primary reason for allocating t costs is to determine whether a product should be sold immediately or processed further. c. The primary reason for allocating t costs is for inventory valuation for financial reporting. d. t costs consist only of overhead, never of materials or direct labor. e. None of the above statements are true. 3. Which of the following costs of a t process would be allocated to the t products? a. materials, labor, and overhead b. labor and overhead only c. materials and labor only d. conversion costs less by-product values e. prime costs less by-product values 4. The t cost allocation method that yields the same gross margin percentage for each product is the: a. net realizable value method. b. sales-to-production-ratio method. c. physical units method. d. constant gross margin percentage method. e. sales-value-at-split-off method. 5. The t cost allocation method that assigns t production costs based on the proportionate share of eventual revenues less further processing costs is the: a. net realizable value method. b. sales-to-production-ratio method. c. physical units method. d. constant gross margin percentage method. e. sales-value-at-split-off method. 6. The secondary product recovered in the course of manufacturing a primary product during a t process is: a. a by-product. b. a t product. c. a replacement product. d. a split-off product. e. none of the above. 7. Which of the following t cost allocation methods is not acceptable for financial reporting under generally accepted ing principles? a. net realizable value method b. sales-value-at-split-off method c. physical units method d. constant gross margin percentage method e. All of the methods are acceptable under GAAP.
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Use the following information for Questions 8 through 10:
Allison, Inc., produces two products, X and Y, in a single t process. Last month the t costs were $75,000 when 10,000 units of Product X and 15,000 units of Product Y were produced. Additional processing costs were $15,000 for Product X and $10,000 for Product Y. Product X sells for $10, and Product Y sells for $5. 8. The t cost allocations to Products X and Y using the net realizable value method would be: X
a. b. c. d. e.
Y
$30,000 $45,000 $42,500 $32,500 $42,857 $32,143 $45,000 $30,000 none of the above.
9. The t cost allocations to Products X and Y using the physical units method would be: X
a. b. c. d. e.
Y
$30,000 $45,000 $42,500 $32,500 $42,857 $32,143 $45,000 $30,000 none of the above.
10. The t cost allocations to Products X and Y using the constant gross margin percentage method would be: X
a. b. c. d. e.
Y
$30,000 $45,000 $42,500 $32,500 $42,143 $32,857 $45,000 $30,000 none of the above.
11. Nathan Company produces three products (A, B, and C) in a single t process. All of the products are salable immediately upon split-off. Alternatively, any of the products could be processed further and sold at a higher price. Cost and price information is as follows: Product
Price at Split-Off
A B C
Additional Processing Cost
Price After Processing
Unit Volume
$10,000 25,000 50,000
$12 18 30
10,000 5,000 8,000
$10 15 20
The decision that would maximize profits would be: A
a. b. c. d. e.
sell now process further sell now process further none of the above.
B
C
sell now process further process further sell now
sell now process further sell now process further
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12. Laker Company produces two products along with a single by-product. The t process costs total $200,000. Product A can be sold for $450,000 after additional processing of $250,000; Product B can be sold for $600,000 after additional processing of $200,000. The by-product BP can be sold for $25,000 after packaging costs of $5,000. The by-product is ed for using the by-product revenue deducted from the main product cost approach. What would be the t cost allocation using the net realizable value method? A
a. b. c. d. e.
B
$60,000 $120,000 $66,667 $133,333 $77,143 $102,857 $85,714 $114,286 none of the above
13. Lankip Company produces two main products and a by-product out of a t process. The ratio of output quantities to input quantities of direct material used in the t process remains consistent from month to month. Lankip employs the physical units method to allocate t production costs to the two main products. The net realizable value of the by-product is used to reduce the t production costs before the t costs are allocated to the main products. Data regarding Lankip’s operations for the current month are presented below. During the month, Lankip incurred t production costs of $2,520,000. The main products are not marketable at the split-off point and, thus, have to be processed further. First Main Product
Monthly output in pounds............ Selling price per pound............... Separable process costs............
Second Main Product
90,000 $30 $540,000
By-Product
150,000 $14 $660,000
60,000 $2
The amount of t production cost that Lankip would allocate to the Second Main Product by using the physical units method to allocate t production costs would be: a. $1,200,000. b. $1,260,000. c. $1,500,000. d. $1,575,000. e. $1,650,000. Use the following information for Questions 14 and 15:
Petro-Chem, Inc., is a small company that acquires high-grade crude oil from low-volume production wells owned by individuals and small partnerships. The crude oil is processed in a single refinery into Two Oil, Six Oil, and impure distillates. Petro-Chem does not have the technology or capacity to process these products further and sells most of its output each month to major refineries. There were no beginning inventories for finished goods or work in process on November 1. The production costs and output of Petro-Chem for November are as follows: Crude oil acquired and placed in production........................... Direct labor and related costs.................................................. Factory overhead....................................................................
$5,000,000 2,000,000 3,000,000
Production and sales: Two Oil: 300,000 barrels produced; 80,000 barrels sold at $20 each Six Oil: 240,000 barrels produced; 120,000 barrels sold at $30 each Distillates: 120,000 barrels produced and sold at $15 per barrel
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14. The portion of the t production costs assigned to Six Oil based on physical output would be: a. $3,636,000. b. $3,750,000. c. $1,818,000. d. $7,500,000. e. $4,800,000. 15. The portion of the t production costs assigned to Two Oil based on the relative sales value of output would be: a. $4,800,000. b. $4,000,000. c. $2,286,000. d. $2,500,000. e. $4,445,000.
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PRACTICE TEST EXERCISE 1 Ron Chemicals produces four products from a t process costing $150,000 per month. After leaving the t process, the products must be further refined before they are salable. You have been provided with the following information: Product
A-1 B-3 C-2 Q-9
Volume
15,000 25,000 10,000 50,000
Further Processing Costs
Selling Price per Unit
$350,000 400,000 100,000 250,000
Required:
1. Allocate the t costs using the physical units method.
2. Allocate the t costs using the net realizable value method.
$80 40 22 10
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EXERCISE 2 Bishop Corporation produces three products at a t manufacturing cost of $1,250,000. The following information has been provided: Product
Volume
A B C
25,000 40,000 35,000
Further Processing Costs
$750,000 750,000 210,000
Selling Price per Unit
$40 50 20
Required:
Allocate the t costs using the constant gross margin percentage method.
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EXERCISE 3 Quorum, Inc., has t processing costs of $1,000,000. There are no further processing costs. The demand for Quorum’s products has been fluctuating greatly; production has remained relatively constant. The following information for the past year has been provided: Product
Units Sold
Q-80 R-34 S-99 T-14 U-62
25,000 40,000 35,000 50,000 75,000
Selling Price per Unit
Units Produced
$4.00 5.00 2.00 1.50 3.50
Required:
Allocate the t costs using the sales-to-production-ratio method.
30,000 30,000 50,000 60,000 80,000
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EXERCISE 4 Granite City Monument Works is a manufacturer of cemetery headstones and architectural granite slabs. Granite City excavates blocks of granite from its quarry from its t processes of Quarry and Cutting. Two t products (cemetery monuments and architectural granite) are produced along with a by-product called grit. Cemetery monuments are cut, polished, and engraved in a variety of standard shapes, sizes, and patterns and sold to funeral homes. Architectural granite slabs are special-ordered by contractors for office buildings. These slabs are cut and polished to exacting specifications. The small pieces of granite resulting from the cutting process are crushed and sold to farm-supply outlets as poultry grit. Granite City has provided the following costs and output information: Process
Cost
Tons of Output
Quarry $350,000 100,000 Cutting 250,000 90,000 Monuments 300,000 25,000 Granite slabs 400,000 60,000 Grit 10,000 5,000 Quarry and Cutting are t processes. A local farm-supply distributor purchases all of the grit that is produced at $40 per ton. Assume that Granite City uses the physical units method to allocate t costs. Required:
1. What would be the cost per ton of monuments and granite slabs, assuming that the grit is ed for as “Other Income”?
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EXERCISE 4 (Continued) 2. What would be the cost per ton of monuments and granite slabs, assuming that the grit is ed for as by-product revenue deducted from the main product cost?
EXERCISE 5 Taldot Company produces three products (X, Y, and Z) in a t process costing $100,000. The products can be sold as they leave the process, or they can be processed further and sold. The cost ant has provided you with the following information: Product
Unit Volume
Sales Price at Split-Off
Separable Further Processing Costs
X 3,000 $10 $60,000 Y 4,000 15 50,000 Z 8,000 20 90,000 Assume that all processing costs are variable costs.
Sales Price After Further Processing
$25 30 35
Required:
Which products should Taldot sell at split-off, and which products should be processed further?
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“ C A N YO U ? ” C H E C K L I S T Can you define the t product, split-off point, by-product, and separable costs?
Can you allocate t product costs using a benefits-received approach such as the: physical units method? weighted average method? Can you allocate t product costs using a relative market value approach such as the:
sales-value-at-split-off method? net realizable value method? constant gross margin percentage method? sales-to-production-ratio method?
Can you identify different methods for ing for by-products? Can you explain how to distinguish between a by-product and a main product?
Can you explain t cost allocations related to: output decisions? further processing decisions? pricing of t products? pricing based on the cost of further production? Can you explain how t production costing could be used in a service industry?
ANSWERS KEY TEST 1. 2. 3. 4. 5.
separable costs sales-to-production-ratio method physical units method sales-value-at-split-off method net realizable value method
6. weight factor 7. Noncost methods 8. split-off point 9. replacement cost method
MULTIPLE-CHOICE QUIZ 1. e 2. c 3. a
4. d 5. a 6. a
7. e
t Product and By-Product Costing 8. b
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Net realizable values are computed as follows: X: (10,000 units × $10) – $15,000 = $ 85,000 Y: (15,000 units × $ 5) – $10,000 = 65,000 Total net realizable value = $150,000 t cost allocation ratios are computed using the net realizable value method, and t cost allocation is performed as follows: X: ($85,000 / $150,000) × $75,000 = $42,500 Y: ($65,000 / $150,000) × $75,000 = $32,500
9. a
10. c
t cost allocation ratios are computed using the physical units method, and t cost allocation is performed as follows: X: (10,000 units / 25,000 units) × $75,000 = $30,000 Y: (15,000 units / 25,000 units) × $75,000 = $45,000 t cost allocation ratio is computed using the constant gross margin percentage method as follows: Estimated gross margin = $175,000 – $75,000 – $25,000 = $75,000 Estimated gross margin ratio = $75,000 / $175,000 = 42.857% t cost allocation is computed as follows: X: $100,000 – $15,000 – ($100,000 × 42.857%) = $42,143 Y: $75,000 – $10,000 – ($75,000 × 42.857%) = $32,857
11. d
A: Incremental revenue if processed further = ($12 – $10) × 10,000 units = $20,000 Additional processing cost = $10,000 Conclusion: Process further because the incremental revenue is higher than the incremental costs. B: Incremental revenue if processed further = ($18 – $15) × 5,000 units = $15,000 Additional processing cost = $25,000 Conclusion: Sell immediately because the incremental revenue is lower than the incremental costs. C: Incremental revenue if processed further = ($30 – $20) × 8,000 units = $80,000 Additional processing cost = $50,000 Conclusion: Process further because the incremental revenue is higher than the incremental costs.
12. a
Adjusted t cost after reduction of net sale of by-product = $200,000 – ($25,000 – $5,000) = $180,000 t cost allocation ratios are computed using the net realizable value method as follows: A: $450,000 – $250,000 = $200,000 B: $600,000 – $200,000 = 400,000 Total net realizable value = $600,000 t cost allocation is computed as follows: A: $200,000 / $600,000 × $180,000 = $60,000 B: $400,000 / $600,000 × $180,000 = $120,000
13. c
Total revenue $2,520,000 – By-product net sales (60,000 pounds × $2) = $2,400,000 Allocation ratio for Second Main Product = 150,000 pounds / (90,000 pounds + 150,000 pounds) = 0.625 t cost allocated to Second Main Product = $2,400,000 × 0.625 = $1,500,000
14. a
Total units produced = 300,000 + 240,000 + 120,000 = 660,000 barrels Allocation ratio for Six Oil = 240,000 barrels / 660,000 barrels = 0.3636 t cost allocated to Six Oil = ($5,000,000 + $2,000,000 + $3,000,000) × 0.3636 = $3,636,000
15. b
Two Oil ($20 × 300,000 barrels) = $ 6,000,000 Six Oil ($30 × 240,000 barrels) = 7,200,000 Distillates ($15 × 120,000 barrels) = 1,800,000 Total $15,000,000 Allocation ratio = $6,000,000 / $15,000,000 = 40% t cost allocation = ($5,000,000 + $2,000,000 + $3,000,000) × 40% = $4,000,000
166
Chapter 7
PRACTICE TEST EXERCISE 1 (Ron Chemicals) 1. Physical Units Method Product: Units............................................................ Allocation %................................................ t cost allocated (% × $150,000)..........
A-1 15,000 15% $22,500
B-3 25,000 25% $37,500
C-2 10,000 10% $15,000
Q-9 50,000 50% $75,000
Total 100,000
A-1 15,000 × $80 $1,200,000 350,000 $ 850,000 46.7% $70,054.95
B-3 25,000 × $40 $1,000,000 400,000 $ 600,000 33.0% $49,450.55
C-2 Q-9 Total 10,000 50,000 × $22 × $10 $220,000 $500,000 100,000 250,000 $120,000 $250,000 $1,820,000 6.6% 13.7% $9,890.11 $20,604.40 $ 150,000
B 40,000 × $50 $2,000,000
C 35,000 × $20 $700,000
$750,000
$210,000
$150,000
2. Net Realizable Value Method Product: Units............................................................ Unit price..................................................... Total revenue............................................... Less: Further processing costs.................. Net realizable value..................................... Allocation %................................................ t cost allocated (% × $150,000)*......... *Differences due to rounding
EXERCISE 2 (Bishop Corporation) Constant Gross Margin Percentage Method Product: A Units............................................................ 25,000 Unit price..................................................... × $40 Revenue...................................................... $1,000,000 Less: t processing cost........................ Less: Separable further processing costs. . $750,000 Gross margin..............................................
Total
$3,700,000) (1,250,000) (1,710,000) $ 740,000)
Gross margin ratio = $740,000 / $3,700,000 = 20% t Cost Allocation Revenue...................................................... $1,000,000) Less: Gross margin at 20%........................ (200,000) Less: Separable further processing costs. . (750,000) t cost allocated..................................... $ 50,000)
$2,000,000) (400,000) (750,000) $ 850,000)
$ 700,000) (140,000) (210,000) $ 350,000)
$3,700,000)
$1,250,000)
EXERCISE 3 (Quorum, Inc.) Sales-to-Production-Ratio Method Product
Q-80 R-34 S-99 T-14 U-62 Total
Units Sold
25,000 40,000 35,000 50,000 75,000 225,000
Percentage of Total Sales
11.11% 17.78% 15.56% 22.22% 33.33%
Units Produced
30,000 30,000 50,000 60,000 80,000 250,000
Percentage of Total Production
Sales-toProduction Ratio
t Cost Allocation Ratio
12.00% 12.00% 20.00% 24.00% 32.00%
0.9259 1.4815 0.7778 0.9259 1.0417 5.1528
17.97% 28.75% 15.09% 17.97% 20.22%
t Cost Allocation
$ 179,695 287,511 150,943 179,695 202,156 $1,000,000
167
t Product and By-Product Costing
EXERCISE 4 (Granite City Monument Works) Sales of grit (5,000 tons × $40)............................ Less: Separable costs of processing................... Shown as “Other Income”.....................................
$200,000 10,000 $190,000
1. Grit ed for as “Other Income”: t cost to be allocated = $350,000 Quarry + $250,000 Cutting = $600,000 Product: Tons................................................................ Allocation ratio................................................ t cost allocation (% × $600,000)............. Add: Separable further processing costs....... Total................................................................ Divided by tons............................................... Cost per ton....................................................
Monuments 25,000 29.412% $176,472 300,000 $476,472 ÷ 25,000 $ 19.06
Slabs 60,000 70.588% $423,528 400,000 $823,528 ÷ 60,000 $ 13.73
Total 85,000 $600,000
2. Grit ed for as by-product revenue deducted from main product cost: t cost to be allocated = $350,000 Quarry + $250,000 Cutting – $190,000 By-product net sales = $410,000 Product: Tons................................................................ Allocation ratio................................................ t cost allocation (% × $410,000)............. Less: Separable further processing costs...... Total................................................................ Divided by tons............................................... Cost per ton....................................................
Monuments 25,000 29.412% $120,589 300,000 $420,589 ÷ 25,000 $ 16.82
Slabs 60,000 70.588% $289,411 400,000 $689,411 ÷ 60,000 $ 11.49
Total 85,000 $410,000
EXERCISE 5 (Taldot Company) Product X Y Z
Incremental Revenue if Processed Further $ 45,000 ($25 – $10) × 3,000 60,000 ($30 – $15) × 4,000 120,000 ($35 – $20) × 8,000
Separable Further Processing Costs $60,000 50,000 90,000
Additional Contribution Margin $(15,000) 10,000 30,000
Based on the analysis above, Product X should be sold immediately at the split-off point. Products Y and Z should be processed further and then sold because they can generate more profit if processed further.
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