Cost Accounting: Joint Costs
In cost accounting, you can imagine many products that start off in joint production. If you make three models of blue jeans, you may cut and sew the same type of denim at the beginning of production. For a while, the three types of jeans look the same. You’re in joint production, and you’re incurring joint costs.
At some point, you separate production. One model of jeans can be distinguished from the models. As you produce jeans separately, you incur costs separately.
It’s time to connect three terms. Joint costs are production costs incurred in creating two (or more) products. The splitoff point is the point when the costs of two or more products can be separately identified. After splitoff, each product incurs separable (or independent) costs.
Figure a product’s total cost in cost accounting
When your production involves some joint costs, you need to change your thinking about total costs. To compute total costs, you use a before-and-after process. The product’s total cost are a portion of the joint costs (incurred before splitoff point) plus the separable costs (incurred after splitoff point).
Say you make two types of leather purses. Both purses go through the same production process. Each product incurs a portion of the joint costs of production. But the process doesn’t end there. In this case, you’d expect to have costs after splitoff.
Sure, both purses go through a process to treat and shape leather — that’s in joint production. But they each have different straps and different metal pieces added. That work (the separable costs) occurs after splitoff. To price both purses, you need to add the joint costs incurred to the separable costs.
It’s possible that two products incur no additional costs after splitoff. At first, that may seem unlikely, but it happens all the time. In food production, for example, joint production costs can stop at splitoff.
A dairy farmer milks cows. The raw milk can generate cream and skim milk. The same input (raw milk) creates two outputs. After the products reach the splitoff point, production and costs stop. The farmer has two products to sell.
Set the sales value of a byproduct in cost accounting
In the cost accounting world, a byproduct is a product that is produced during joint production. It’s something produced while you’re making something else. Call it an extra or a side effect of production. Even though producing the byproduct isn’t your main goal, it shares joint costs with the real product.
A byproduct has a lower sales value than other products in joint production. Sales value? Here’s how to calculate a product’s sales value:
Product sales value = Number of units produced x sale price per unit
You can tell a byproduct because it isn’t the primary reason you’re running production. The revenue produced (product sales value) is typically so small that you wouldn’t run production for just the byproduct. But the sales value of the byproduct (just like any other product) can change. Over time, your byproduct’s revenue may become more attractive. (Well, it can also become less attractive, too.)