© 14-1 Process, Joint and BY- Product Costing.

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Process, Joint and BY-Process, Joint and BY-Product Costing Product Costing


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Process AccountingProcess Accounting

Process costing system measures the cost of products under conditions of continuous production, sequential processing and homogeneous output. The procedure under such a system of costing essentially involves averaging the total costs of a process or a department. It is used in industries such as chemicals, food processing, breweries, petroleum refining, paper, glass, metal manufacturing and so on.

Process costing assumed a sequential flow of cost from one process to another as unit of output pass through a

number of specified production processes.


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COST ACCUMULATION IN COST ACCUMULATION IN PROCESS COSTINGPROCESS COSTING

The procedure to determine the cost will depend on, firstly, the stage of completion of the product, in each process,

secondly, the extent of wastage, spoilage of units in the process and, thirdly, the inter-process profits.

In cases where some units are complete, while others are incomplete or partially complete, for the purpose of

cost accumulation, the partially completed units are to be converted into comparable

equivalent units.

Equivalent units = [Actual number of partially completed units × Stage of completion]


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Completed Units

Example 1: A product passes through two processes, A and B.

During the month ended June 30, 1,500 units were produced. The

detailed cost break-up is as follows:

Process A Process B

Direct materials

Direct labour

Direct expenses

Rs 90,000

75,000

15,000

Rs 75,000

1,50,000

18,000

Indirect overhead costs during the period were Rs 60,000

apportioned to the processes on the basis of direct labour cost. No

work-in-progress existed at the beginning and end of the period.

Prepare relevant process accounts.


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Solution

Process A Account

To direct materialsTo direct labourTo direct expensesTo indirect overheads (Rs 60,000 × 1/3)

Rs 90,00075,00015,000

20,0002,00,000

By Cost of output transferred to process B Rs 2,00,000

________2,00,000

Process B Account

To process A (cost transferred)To direct materialTo direct labourTo direct expensesTo indirect overheads (Rs 60,000 × 2/3)

Rs 2,00,000 75,0001,50,000

18,000

40,000 4,83,000

By cost of output transferred to finished goods inventory Rs 4,83,000

________4,83,000

Finished Goods Inventory

To process B (cost of output) 4,83,000


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Example 2

From the following information of ABC Manufacturers Limited, prepare a statement of equivalent units.

Opening inventory: Partially completed units (40 per cent complete)

Units introduced during the period

Closing inventory (partially completed units: 70 per cent complete)

600

10,000

2,000

Solution

Statement of Equivalent Units

1. Work necessary to complete opening inventory (600 × 0.60)

2. Work necessary to start and finish units introduced during the current year

(10,000 – 2,000 partially completed units)

3. Work performed on closing inventory (2,000 × 0.70)

Total number of equivalent units

360

8,000

1,400

9,760


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Example 3

From the following production record of XYZ Manufacturing Company Ltd, prepare a statement of equivalent units:

Units in process-opening 2,000

Stage of completion (%): material 100

labour 60

overheads 50

New units introduced 20,000

Units completed 18,000

Units in process-closing 4,000

Stage of completion (%): material 100

labour 50

overheads 40


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Solution

Table 1 Statement of Equivalent Units

Input Particulars Number of

units (comple

tedor otherwise)

Work performed during the current

period [stage of completion (per

cent)]

Equivalent producedunits: input units× stagecompletion in respect of

Material

Labour

Over-heads

Material

Labour Over-heads

Openinginventory2,000 units+20,000 unitsintroducedduring thecurrent period

_____22,000

Work expended onopening inventories(100 per cent stage ofcompletion)Units started and completedduring the current period(18,000 total unitscompleted inventory)Closing inventory(work-in-process)

2,000

16,000

4,00022,000

Nil

100

100

40

100

50

50

100

40

—

16,000

4,00020,000

800

16,000

2,00018,800

1,000

16,000

1,60018,600


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Process Accounts/Production Process Accounts/Production Cost ReportCost Report

The cost of production is shown in the form of a production cost report and/or process cost account.

The total cost of production of each process is split into the cost of output and the closing inventory /work-in-process.

The distribution between these two elements depends on the method of valuation of work-in-process, namely, (i)weighted average method and (ii) first-in-first-out (FIFO) method.


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Weighted Average Cost MethodWeighted Average Cost MethodUnder this method, total costs in process are divided by equivalent units produced by the process to ascertain

the cost per equivalent unit.

Exhibit 1: Process Account (Weighted Average Cost Method).

ToWork-in-process (opening inventory)

To Current costs

Material

Labour

Overheads

To Closing work-in-process inventory to be carried to the next period

By Cost of completed units transferred to next process/finished goods inventory A/c

By Closing work-in-process


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FIFO Method FIFO Method Unlike the weighted average cost method, this method is based on the assumption

that units in process at the beginning of the period are the first to be completed and accordingly the first costs incurred in the current period should be

attached to the units of the opening work-in-process inventory.

Exhibit 2: Process Account (FIFO Method)

To Work-in-process opening inventory during

the current period (units partially

completed in earlier period)

To Current costs

1. To complete opening inventory units

2. To work initiated on new units in

the current period in this process:

(a)Some of which are completed

and transferred

(b)Some of which are not yet completed

and carried as opening inventory

for next period

To Closing work-in-process inventory

to be carried forward to the next period

By units completed

1. Units started in earlier period

and completed during the current period

2. Units started and completed during the current period

3. Units started but not completed during the current period


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Example 4

For the firm in Example 3, assume the following:

Cost of 2,000 units in process (opening):

Materials

Labour

Overheads

Processing costs during the current period

Materials

Labour

Overheads

Rs 6,000

3,600

2,400

69,900

56,560

58,360

Prepare a cost of production report for the current period using (a) weighted average, and (b) FIFO costing methods.


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Solution

Cost of Production Report of Process A (Weighted average cost method)

Flow of completed or partially completed units:

Opening 2,000

Introduced 20,000

Total in process 22,000

Less completed 18,000

In process 4,000

Equivalent units in process:

Conversion costs

Material Labour Overhead

Units completed 18,000 18,000 18,000

Equivalent units in ending inventory 4,000 2,000 1,600

22,000 20,000 19,600


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Total cost to be accounted for:

Material Labour Overheads

Total

Work-in-process (opening) Rs 6,000 Rs 3,600 Rs 2,400 Rs 12,000

Current costs 69,900 56,560 58,360 1,84,820

Total cost in process 75,900 60,160 60,760 1,96,820

Equivalent units (EU) in process 22,000 20,000 19,600 —

Cost per equivalent unit in process

(Total cost ÷ EU) 3.45 3.008 3.1 9.558

Costs accounted for:

Transferred to finished goods

inventory (18,000× Rs 9.558) 1,72,044

Work-in-process (closing inventory)

Materials (4,000× 100 per cent× Rs 3.45) Rs 13,800

Labour (4,000× 0.50× Rs 3.008) 6,016

Overheads (4,000× 0.40× Rs 3.1) 4,960 24,776

Total costs accounted for 1,96,820

(Contd.)


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Cost of Production Report of Process A (FIFO method)

Flow of completed or partially completed units:

Opening 2,000

Introduced 20,000

Total in process 22,000

Less completed 18,000

In process 4,000

Equivalent units manufactured:

Conversion costs


Units completed 18,000 18,000 18,000

Equivalent units in ending inventory

4,000 2,000 1,600

Equivalent units in process 22,000 20,000 19,600

Less equivalent units in opening inventory

2,000 1,200 1,000

Equivalent units manufactured 20,000 18,800 18,600


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Total costs to account for:


Total

Opening work-in-process

— — — Rs 12,000

Current costs Rs 69,900 Rs 56,560 Rs 58,360 1,84,820

Total costs in process 1,96,820

Equivalent units manufactured

20,000 18,800 18,600 —

Cost per equivalent unit manufactured

3.495 3.0085 3.1376 9.6411

Costs accounted for:

Transferred to finished goods inventory

(Contd.)


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First batch:

Work-in-process opening inventory

Rs 12,000

Add conversion costs:

Labour (2,000× 0.40× Rs 3.0085)

2,406.8

Overheads (2,000× 0.50× Rs 3.1376)

3,137.6 Rs 17,544.4

Second batch:

Started and completed (16,000× Rs 9.6411) 1,54,257.6

Work-in-process (closing):

Materials (4,000× 100 per cent× Rs 3.495) 13,980

Labour (4,000× 0.50× Rs 3.0085)

6,017

Overheads (4,000× 0.40× Rs 3.1376)

5,020.16 25,017.16

1,96,819.16


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Comparison For comparison of the two costing methods, summary results of important items are listed below:

FIFO Weighted average cost

(A) Cost of output transferred from

(i) Opening inventory Rs 17,544.40 Rs 1,72,044

(ii) Current production 1,54,257.60 Rs 1,71,802

(B) Closing work-in-process 25,017.16 24,776

1,96,819.16 1,96,820


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Spoilage

The spoilage of units under process costing may take place due to a variety of reasons, like use of sub-standard material, poor workmanship, evaporation, shrinkage, break-down of machines, and so on. The effect of spoilage is that the number of actual units produced is less than the units introduced initially. The spoilage or wastage may be normal or abnormal. The unit cost with normal spoilage.

=Total process costs – Salvage value of normal spoilage

Total units introduced – Normal loss in units

Abnormal Loss

Abnormal loss = [(Abnormal loss in units × Unit production cost) – Salvage value of abnormal spoilage]

Inter-Process Profits

Inter-process profit is the profit arising out of transfer of the product of one process to the other on the basis of market/inflated price.


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Example 5

Six hundred kgs of material was charged to process I at the rate of Rs 4 per kg. The direct labour accounted for Rs 200 and the other departmental expenses amounted to Rs 760. The normal loss is 10 per cent of input. During the period, the actual production was 500 kgs and 100 kgs was scrap. Assuming that the scrap is saleable at Rs 2 per kg, prepare a ledger account of process I, showing the values of normal and abnormal losses.

Solution

Process I Account

Particulars Units (kgs)

Amount Particulars Units (kgs)

Amount

To materials 600 Rs 2,400 By normal loss (600× 0.10)

60 Rs 120

To wages 200 By abnormal loss 40 240

To departmental expenses 760

By process II (500 units transferred at Rs 6 each) 500 3,000

600 3,360 600 3,360


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Working Notes

Cost per unit = (Rs 3,360 - Rs 120)/ 540 units = Rs 6

Amount of abnormal loss

Units introduced 600

Less normal loss (10 per cent) 60

Normal output expected 540

Less actual output achieved 500

Abnormal loss (units) 40

(×) Cost per unit Rs 6

Total loss 240

Less sale value of scrap (40× Rs 2) 80

Total 160


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Inter-Process ProfitInter-Process Profit

Example 6 (Inter-Process Profits)

A product passes through three processes, A, B, and C. The output of process A and B is charged to the next process at a price calculated to give a profit of 16.67 per cent on transfer price while the output of process C is charged to the finished stock account at a profit of 13.33 per cent on the transfer price. From the following particulars, prepare the process cost accounts and calculate the amount of reserve that should be made in respect of the stock in hand.

Process A Process B Process C

Materials and labour Rs 7,000 Rs 2,800 Rs 4,800

Closing stock 2,000 2,800 2,000

There was no stock in hand at the beginning of the period. The closing stocks are valued at prime cost in each process.


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Solution

Process A Account

Particulars Amount Particulars Amount

To materials and labour Rs 7,000 By closing stock Rs 2,000

To profit (Rs 6,000 × 0.1667) 1,000

By process B (Rs 5,000 × 120/100) 6,000

8,000 8,000

Process B Account


To process A Rs 6,000 By closing stock Rs 2,800

To material and labour 2,800 By process C (Rs 6,000 × 120/100) 7,200

To profit (Rs 7,200 × 0.1667) 1,200 ________________

10,000 10,000


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Process C Account


To process B Rs 7,200 By closing stock Rs 2,000

To materials and labour 4,800 By finished goods (10,000 × 115.38/100)

11,538

To profit (Rs 11,538 × 0.1333) 1,538

____________

13,538 13,538


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Working Notes

1 Profit of 16.67 per cent on transfer means 20 per cent on cost price.

2 Likewise, profit of 13.33 per cent on transfer price means 15.38 per cent on cost.

3 Provision for unrealised profit:

Process A: Nil

Process B: (Rs 1,000 × 2,800)/8,800 = Rs 318

Process C: Closing stock of process C of Rs 2,000 is made up of respective cost proportions of C: B, that is, 2:3 (Rs 4,800: Rs 7,200).


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Statement of Profit

Process A Rs 1,000

Process B Rs 1,200

Less provision for unrealised profit 318 882

Process C 1,538

Less provision for unrealised profit 313 1,225

Profit realised 3,107

Process C’s share is = Rs 2,000 × 2/5 = Rs 800

Process B’s share is = Rs 2,000 × 3/5 = Rs 1,200

Profit included in Rs 1,200 (process B’s cost) is = Rs 1200 × 20/120 = Rs 200(i)

Profit included in Rs 1,000. This includes part of process A’s costs: Rs 1,000 × 60/88= Rs 682.

Rs 682 includes profit element of = Rs 682 × 20/120 = Rs 113 (ii)

Total profit included in process C = Rs 313 (200 + 113) (i + ii)


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Alternatively

Process A Account

Particulars Total(Rs)

Cost(Rs)

Profit (Rs)

Particulars Total(Rs)

Cost(Rs)

Profit(Rs)

To materials and labour

7,000 7,000 — By closingstock

2,000 2,000 —

To profit (Rs 5,000 × (50/3) × (3/250) 1,000 — 1,000

By processB (transferred) 6,000 5,000 1,000

8,000 7,000 1,000 8,000 7,000 1,000


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Process B Account

Total(Rs)

Cost(Rs)

Profit(Rs)

Total(Rs)

Cost(Rs)

Profit(Rs)

To process A 6,000 5,000 1,000 By Closing stock (2,800 × 1,000) ÷8,800

2,800 2,482 318


2,800 2,800 — By process C (transferred)

7,200 5,318 1,882

To profit and loss A/c (Rs 6,000 × (50 × 3) ÷ (3 × 250)) 1,200 — 1,200

10,000 7,800 2,200 10,000 7,800 2,200


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Process C Account

To process B

Rs 7,200 Rs 5,318 Rs 1,882 By closing stock

Rs 2,000 Rs 1,687 Rs 313


4,800 4,800 — By finished goods A/c (at 115.38 per cent of cost)

11,538 8,431 3,107

To profit and loss A/c (0.1333 × Rs 11,538) 1,538 — 1,538

13,538 10,118 3,420 13,538 10,118 3,420


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Joint ProductsJoint Products

Two or more products produced simultaneously from a common set of inputs through a single manufacturing (joint) process are called joint products. The joint products can be sold either at the stage of production (split-off point) itself or they can be processed further.

Split-off Point

Split-off point is that stage in the manufacturing process where joint products are separately identifiable.

The costs incurred before the split-off point are called joint/common/inseparable costs and the costs incurred beyond that point are known as separable costs. The crucial factor in accounting for joint products is the allocation of joint costs among the joint/multiple products from the joint process.


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Allocation of Joint CostsAllocation of Joint Costs

(1) Physical Quantities Method/Unit Method

(2) Relative Sales Value/Net Realisable Value (NRV) Method

(3) Net Realisable Value Less Normal Profit Method

(4) Weighted Average Method

The commonly used methods of allocating joint process costs are:


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Example 7. (Allocation of Joint Costs Under Unit Method)

Royal Industries Ltd manufactures products X, Y and Z by processing a specific raw material in Department 1. The production process is such that every 1,100 kgs of raw materials that is put into Department 1 yields 400 kgs of X, 250 kgs of Y and 350 kgs of Z. The total cost of processing a batch of 1,100 kgs of raw materials through Department 1 is Rs 22,000. Allocate the joint costs to the three products using the physical quantity method.

Solution

Joint Cost Allocation Using Unit Method

Product Output (kgs) Rates (per cent) Allocated joint cost

Cost per unit

X

Y

Z

400

250

350

1,000

40

25

35

100

Rs 8,800

5,500

7,700

22,000

Rs 22

22

22

22

Physical Quantities Method/Unit Method

Under the physical quantities method, the total joint costs are allocated to the joint products in proportion to the physical measurement of output.


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This method results in identical unit costs for each product. Identical benefits exist only if the products are homogeneous. It will, therefore, provide a satisfactory basis of allocating joint cost if the different products are homogeneous and their sale prices are relatively close to each other. Otherwise, it may lead to misleading results in that there will be wide divergence in the gross margin of the different products as shown in Table 2.

Table 2 Gross Margin of Different Products

Product X Product Y Product Z

Sales price Rs 33 Rs 44 Rs 66

Less cost of production 22 22 22

Cross margin 11 22 44

Gross margin percentage 33.33 50 66.67


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Relative Sales Value/Net Realisable Value (NRV) Method

In the net realisable value method, joint costs are pro-rated on the basis of the market value of the joint products.

From the facts in Example 7 and Table 2 and assuming all products are sold at the split-off point, joint cost allocation under the relative sale value method would be, as shown in Table 3.

Table 3 Joint Cost Allocation Using Sales Value Method

Product Output (kgs)

Market price

Market value

Rates Allocated joint cost

Cost per unit

X 400 Rs 33 Rs 13,200 132/473 Rs 6,140 Rs 15.35

Y 250 44 11,000 110/473 5,116 20.46

Z 350 66 23,100 231/473 10,744 30.70

1,000 47,300 22,000 22.00

Thus, the costs per unit are in proportion to the sale prices. The relative sale price method generates the same margin percentage (53.48 per cent) for all products. Thus, this approach implies a matching of input costs with revenues generated by each output.


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Assuming that for the firm in Example 7, the additional processing for

products X, Y and Z is done in departments 2, 3 and 4 respectively.

Following are the costs incurred in these departments to process the batch

of 1,100 kgs of materials:

Product Output (kgs) Department Further processing/

separable cost

Unit

cost

X 400 2 Rs 6,000 Rs 15

Y 250 3 4,500 18

Z 350 4 7,000 20


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Assuming no change in market price, joint costs of Royal Industries Ltd would be

allocated as shown in Table 4.

Table 4 Allocation of Joint Costs [Net Realisable Value (NRV) Method]

Product Output

(kgs)

Market

price

Market

value

Separab

le

cost

Net

realisable

value

Rat

es

Allocated

joint

costs

Joint cost

per unit

X 400 Rs 33 Rs 13,200 Rs 6,000 Rs 7,200 72/2

98

Rs 5,315 Rs 13.28

Y 250 44 11,000 4,500 6,500 65/2

98

4,799 19.19

Z 350 66 23,100 7,000 16,100 161/

298

11,886 33.96

1,000 47,300 17,500 29,800 22,000 22.00


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The gross margin rates for each product according to this method are shown in Table 5.

Table 5 Gross Margin Rates

Product X Product Y Product Z

Sales price Rs 33.00 Rs 44.00 Rs 66.00

Less cost of production:

Joint cost 13.28 19.19 33.96

Separable cost 15.00 18.00 20.00

28.28 37.19 53.96

Gross margin 4.72 6.81 12.04

Gross margin rate (percentage) 14.3 15.5 18.21


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Net Realisable Value Less Normal Profit Method

The net realisable value less normal profit method differs from the net realisable value method to the extent the joint costs less normal profits are pro-rated.

Table 6 Joint Cost Allocation Using NRV Less Normal Profit Method

Product Output(kgs)

Market value

Normal profit

Separablecosts

Joint costallocation

Joint costper unit

X 400 Rs 13,200 Rs 2,177 Rs 6,000 Rs 5,023 Rs 12.557

Y 250 11,000 1,814 4,500 4,686 22.744

Z 350 23,100 3,809 7,000 12,291 35.117

1,000 47,300 7,800 17,500 22,000

Working Notes

Normal profit ratio = 100 per cent – [Total costs – (Joint + Separable)× 100] ÷ Total market value = 100 per cent – [(Rs 22,000 + Rs 17,500)× 100 ÷ Rs 47,300, 83.5 per cent = 16.5 per cent]


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Weighted Average Method

Where the joint products are heterogeneous, the weighted average cost method provides a reasonable basis for allocating the joint costs.

Continuing with the example of Royal Industries Ltd, assume that the following are the weights assigned to products X, Y and Z after taking into consideration a variety of factors: X, 1; Y, 2; Z, 4. Using the weighted average method, the joint costs are allocated in Table 7.

Table 7 Joint Cost Allocation Using Weighted Average Method

Product Output (kgs)

Weight Weighted output

Ratio Allocated joint cost

Cost per unit

X 400 1 400 4/23 Rs 3,826 Rs 9.56

Y 250 2 500 5/23 4,783 19.13

Z 350 4 1,400 14/23 13,391 38.26

1,000 2,300 22,000


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By-ProductsBy-Products

A by-product is incidental to the process of manufacturing the

main/joint product. The accounting treatment depends on whether

the by-product is sold at the split-off point or is processed further.

The two most commonly-used methods of accounting for by-

products are:

(1) Miscellaneous income method

(ii) Net realisable value method, (NRV)

Recognisation of No Profit on the Sale of By-products

Recognisation of Some Normal Profit on the Sale of By-products


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(i) Miscellaneous Income Method

Under the miscellaneous income method, the income generated by the by-products is treated as a miscellaneous income and all the associated costs are charged to the main product.

(ii) Net Realisable Value Method, (NRV).

According to the NRV method, the by-product is valued at its net realisable value and the joint costs are pro-rated between the main product and the by-product. Joint process cost allocated to by-product = (Sale price of by-products – Selling and distribution costs of by-products).

A variation of this is to recognise some normal profit from the sale of by-products.

Joint cost allocated to by-products = (Sale price of by-products – Normal profit – Selling and distribution costs of by-product).


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Example 8

For the facts contained in Example 7, let as assume further that joint production process also yields by-product (70 kgs) in addition to three main products X, Y, Z. Its selling price is Rs 2 per kg and selling costs are Rs 0.50 per kg. Determine the share of joint costs (i) if firm does not recognize profit on the sale of its by-product; and (ii) if it recognizes 10 per cent profit on such sales.

Solution

Share of Joint Costs

(i) When no profits are recognized:

Sales revenue (70 kgs × Rs 2)

Less selling costs (70 kgs × Rs. 0.50)

Share of joint costs (70 kgs × Rs 1.50)

(ii) When 10 per cent profits are recognised:

Sales revenue (70 kgs × Rs 2)

Less normal profit (Rs 140 × 0.10)

Less selling costs (70 kgs × Rs 0.50)

Share of joint costs (70 kgs × Rs 1.30)

Rs 140

35

105

140

14

35

91


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SELL NOW (AT SPLIT-OFF SELL NOW (AT SPLIT-OFF POINT) OR PROCESS POINT) OR PROCESS

FURTHERFURTHER


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Example 9 (Sell Now or Process Further: Single Product)

A B C Ltd manufactures a single product which it sells to firms which process it further before sale. The normal quarterly operating volume for the company is 50,000 units produced and sold. The relevant cost data are as follows:

Selling price Rs 10.00

Less standard costs:

Direct materials Rs 3.00

Direct labour 1.50

Variable manufacturing overheads 1.00

Fixed manufacturing overheads (Rs 25,000 per quarter) 0.50

Variable selling overheads 1.00

Fixed selling expenses (Rs 12,500 per quarter) 0.25 7.25

Standard profit per unit 2.75


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The company’s management is considering the possibility of further processing the product and selling it directly to the customers. The management estimates that the product can be sold @ Rs 14 per unit after further processing. The following are the estimates of the additional (per unit/ quarter) costs of processing 50,000 units:

Direct labour Rs 1.00

Variable manufacturing overheads 0.50

Variable selling costs 0.20

Additional fixed manufacturing overheads (per quarter) 10,000

Additional sales expenses (per quarter) 5,000

You are required to compute the cost (i) without, and (ii) with further processing. Is further processing advisable?


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Solution

Cost Comparison: Incremental Analysis

Particulars Without further processing

With further processing

Difference from further processing

Per unit Total Per unit Total Per unit Total

SalesLess variables costs:Direct materialDirect labourManufacturingoverheadsSelling overheadsTotalContributionLess separable identifiable fixed costs:ManufacturingSalesProduct marginLess common fixed costs:ManufacturingSalesNet income

Rs 10.00

3.001.50

1.001.006.503.50

Rs 5,00,000

1,50,00075,000

50,00050,000

3,25,0001,75,000

— — 1,75,000

25,00012,500

1,37,500

Rs 14.00

3.002.50

1.501.208.205.80

Rs 7,00,000

1,50,0001,25,000

75,00060,000

4,10,0002,90,000

10,000 5,000

2,75,000

25,00012,500

2,37,500

Rs 4.00

0.001.00

0.500.201.702.30

Rs 2,00,000

50,000

25,00010,00085,000

1,15,000

10,000 5,0001,00,000

——

1,00,000

Since further processing would result in a greater product margin and net income, the new proposal is acceptable.


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Example 10 (Sell or Process Further: Multiple Products)

XYZ Ltd produces three products, A, B and C. One type of a raw material is used for all these products. Raw material enters the process in department 1 of the factory. Department 1 separates material for products A, B and C. During the last quarter, Rs 4,00,000 of material was issued to Department 1. Other direct costs of operating Department 1 were Rs 2,00,000. The output of products A, B and C from Department 1 was: A, 10,000 units; B, 5,000 units; C, 2,000 units.

Products A, B and C can be sold after being processed from Department 1 (split-off point) at prices of Rs 60, Rs 30 and Rs 20 respectively. After the split off, product A could be processed further in Department 2. With additional processing, product A can be sold at Rs 70 per unit. After the split-off, product B could be processed further in Department 3 for Rs 30,000 additional cost, and will fetch Rs 35 per unit after processing. Product C is not suitable for further processing and has to be sold at the point of split-off. What action should be management take?


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Solution

Sell or Process Further: Decision Analysis

Particulars Product A Product B

Sell now Process further

Difference from further processing

Sell now Processfurther

Differences

from further

Processing

Sales Less separable costs Joint cost of Rs 6,00,000 from Department 1

Rs 6,00,000—

Rs 7,00,00050,000

Rs 1,00,00050,000

Rs 1,50,000—

Rs 1,75,00030,000

Rs 25,000

30,000

Irrelevant as costs not affected by the decision

Contribution(decrease)

Rs 6,00,000 6,50,000 50,000 1,50,000 1,45,000 (5,000)

Thus, it is profitable to process product A further because it yields an incremental profit of Rs 50,000, (additional revenue being Rs 1,00,000 and additional cost, Rs 50,000). The decision is based on the assumption that there is no other opportunity cost for using the facilities of Departments 2 and 3.


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By-Product Processed FurtherBy-Product Processed FurtherThere are several methods of accounting for costs of further processing:

(1) Recognition of No Profit on Sale of By-products Method

Under this method, share of joint costs allocated to by-products would be determined by subtracting both selling and further processing costs from the sale price of by-products.

Sale price of by-products – Further processing cost beyond split-off point – Selling cost = Joint costs.

(2) Recognition of Normal Profit on Sale of By-Products/Reversal Cost Method

Under this method, by-products are valued at the price which would have been paid by the firm in making outside purchases for these products.

(3) Separate Cost Record for By-products

This method is most appropriate in situations when the joint manufacturing process yields by-products which are relatively of high value and/or of large quantity; they also require further processing after separation from the joint manufacturing process.


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Example 11 (Reversal Cost Method)

In manufacturing the main product, Hypothetical Ltd processes the incidental waste into two products, A and B. From the following data relating to the products, you are required to prepare a comparative profit and loss statement showing the individual costs and other details. The total costs upto separation point were Rs 3,10,400.

Main product By-product A By-product B

Sales Rs 8,00,000 Rs 64,000 Rs 96,000

Costs after separation 80,000 12,800 14,400

Estimated net profit (per cent to sales value)

20 30

Estimated selling expenses (as per cent to sales value)

20 10 15


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Solution

Statement Showing Allocation of Joint Costs

Particulars By-product A By-product B

Sales Rs 64,000 Rs 96,000

Less: estimated net profit on sale

(20 per cent, A; and 30 per cent, B) 12,800 28,800

estimated selling expenses

(10 per cent, A, and 15 per cent, B) 6,400 14,400

separable costs 12,800 14,400

Share of joint costs allocated 32,000 38,400

Share of main products in joint costs, therefore, would be: Rs 3,10,400 – (Rs 32,000 + Rs 38,400) =Rs 2,40,000.


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Comparative Profit and Loss Account

Particulars Main product By-product A By-product B

Sales revenue Rs 8,00,000 Rs 64,000 Rs 96,000

Less cost of production:

Joints costs 2,40,000 32,000 38,400

Separable costs 80,000 12,800 14,400

Gross profit 4,80,000 19,200 43,200

Less selling expenses 1,60,000 6,400 14,400

Net profit 3,20,000 12,800 28,800

© 14-1 Process, Joint and BY- Product Costing.

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