Joint Product Costing

In some industries, a company takes one common raw material and makes several different types of products with it, such as a petroleum processing company. These companies take one input, petroleum, and then from that petroleum, they make multiple products, such as kerosene, gas, and propane. 

There are a lot of costs going into processing petroleum, but if there are multiple end products, how do we know how much it costs to allocate to each product? How would we know how much we spent on converting petroleum into gas versus petroleum into kerosene? This is why we have a topic called joint product costing.

Joint product costing is when you have one input that makes multiple products and it helps

you allocate the costs. 

Study Tip 😀

Joint Product Costing focuses on allocating joint costs to the final joint products.

Joint products are all the outputs that you’re making from one input. Here our joint products would be kerosene, propane, and gas. You’re spending all this money processing the petroleum, but you haven’t actually separated the petroleum into individual outputs yet.

In other words, you can’t distinguish the costs yet. There comes a certain point though, called the split-off point, when you do separate that one input into the multiple products. At this point the products are distinguishable and you can start allocating their costs. Joint costs are for all of the costs before we actually separate the items into distinguishable items.

In essence, the purpose of joint product costing is to allocate the joint costs. 

Joint Product Costing – Tree Company Example

Let’s use an example of another company, a tree processing company that creates multiple products from the same tree. You take the entire tree, the one input, and begin processing it to create several unique products (i.e., joint products).

For example, from the same tree, you create lumber for construction and you produce firewood for burning. Our two joint products are lumber and firewood. Up until you separate the lumber from the firewood, you have incurred joint costs while processing the tree. You had to cut it down, transport it to your plant, remove the bark, etc. 

Then you get to a point called the split-off point where your firewood and lumber become unique products, meaning you’ve cut both the lumber and the firewood from the original tree. They’re no longer grouped together, which means that the joint costs can then easily be applied to each product individually.

We’re focused on how much of the joint costs to apply to the lumber and how much to apply to the firewood. Before the split-off point, while we’re putting all these costs into processing the tree, how much do we allocate in cost to firewood versus lumber? 

We have three methods of how to allocate joint costs:

1. Volume Method

2. Sales Price at Split-Off Method

3. Net Realizable Value at Split-Off Method

The Volume Method – Joint Product Costs

The volume method simply looks at the total volume that we are producing and then allocates the joint costs based on the volume of each individual unit. For example, let’s say that we spent $5,000 of joint costs processing a tree before the split-off point. At the split-off point, let’s say we’re able to produce 6,000 pounds of wood consisting of 5,000 pounds of lumber and 1,000 pounds of firewood. 

The volume method says out of the 6,000 pounds of product produced, 83% of it is for lumber and 17% of it is for firewood. Therefore, we allocate $4,150 of joint costs to the lumber (83% X $5,000) and $850 of joint costs to the firewood (17% X $5,000).

The Sales Price at Split-Off Point Method – Joint Product Costs

The second method is the sales price at the split-off point method. This method makes the assumption that right at the split-off point, we could sell that product and not put any more costs into it. 

Let’s say we could sell the lumber right at the split-off point for $12,000. We could sell the firewood right at the split-off point for $2,000. Our total sales price at split-off is $14,000. Our lumber accounts for 86% of the sales price at split-off ($12,000/$14,000), and our firewood accounts for 14% of the sales price at split-off ($2,000/$14,000). Therefore, the lumber gets assigned 86% of joint costs, which equals $4,300, and the firewood gets assigned 14% of the joint costs, which equals $700. 

The Net Realizable Value at Split-Off Point Method – Joint Product Costs

The third method is the net realizable value at the split-off point method. This assumes that after the split-off point, we’re going to have to put more costs into our products before we actually sell them. The term net realizable value can be kind of confusing. 

Realizable means the amount that we will eventually sell our product for. It means the revenue that we will generate or realize, and then net simply means that we will have to subtract our costs from our sales amount. Let’s say that we will eventually sell the lumber for $20,000, meaning that $20,000 is the realizable part of the net realizable value.

After the split-off point, we’re going to have to spend $2,000 more in costs to finish the product. To get to the net realizable value, we subtract the $2,000 in costs from the $20,000 sales we’re going to generate. Our net realizable value is $18,000. 

Then, for our firewood, let’s say we’re going to eventually sell it for $3,500. First, we need to incur $400 more in costs. The net realizable value is the $3,500 minus the $400 in costs, which is $3,100.

Between the two products, we have a total net realizable value of $21,100. This means that the lumber makes up 85% of our total net realizable value ($18,000/$21,200) and therefore gets assigned 85% of the joint costs, which are $4,250.

The firewood’s net realizable value makes up 15% of our total net realizable value ($3,100/$21,200) and therefore gets assigned 15% of the joint costs, which are $750. 

By-Products

Byproducts are made from the same input that makes the other joint products, but byproducts are not as important as the joint products. Meaning that the byproducts don’t generate a significant amount of revenue and they’re not the main reason why we’re processing that one input.

An example of a byproduct of processing trees could be toothpicks. As we’re processing the trees, one of the outputs we get is toothpicks, but we can’t sell them for very much, and they’re not the main reason why we’re processing the tree. We’re processing it for the lumber and the firewood. The toothpicks would be the byproduct. 

How do we account for byproducts? There are two methods. The first method is you take the net realizable value of the byproduct at split-off and subtract it from your joint costs.

First, you figure out the net realizable value of your byproduct. Let’s say that we’ll be able to sell these toothpicks for $800, but first, we will need to incur $200 more in costs. Our net realizable value is then $600. Our total joint costs are $5,000. We take the $600 net realizable value of the byproduct and subtract that from the $5,000. Now our joint costs are only $4,400 ($5,000 – $600). Now we only have to allocate that $4,400 among the firewood and the lumber. 

The second, and less common way of accounting for byproducts, is to take their sales value and record it as another income item on the income statement.

Study Tip 😀

Byproducts are insignificant outputs. We can either subtract their NRV from the joint costs or we can record it as other income.