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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
Material Labour Overheads
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:
Material Labour Overheads
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
Particulars Amount Particulars Amount
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
Particulars Amount Particulars Amount
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
To materials and labour
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
To materials and labour
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