Joint Cost Allocation Methods

Joint cost is the manufacturing cost incurred on a joint production process which takes common inputs but simultaneously produces multiple products called joint-products e.g. processing of crude oil simultaneously yields gasoline, diesel, jet fuel, lubricants and other products. In order to allocate costs to such joint products, costs accountants employ one of the several cost allocation methods. Most common of those methods are:

Physical measurement method

Joint costs are allocated based on number of units or physical quantity such as weight, volume or length of each product relative to total production. This method can be represented in the following formula:

Cost Allocated to a Joint Product =Quantity of the Product× Total Joint Costs
Quantity of Total Production

This method is suitable where physical quantity of joint-products closely reflects their costs e.g. different shades of a paint obtained from a single process may be allocated costs using physical quantity method.

Relative sales value method

This method allocates joint costs on the basis of estimated sales value of a given joint product relative to the sales value of total joint production. This is illustrated in the following formula:

Cost Allocated to a Joint Product =Sale Value of the Product×Total Joint Costs
Sales Value of Total Production

This method is suitable when physical quantity of joint products does not reflect their value and a reliable estimate of their sale value can be easily made.

Net realizable value (NRV) method

For products that need further processing, NRV method is more suitable because it takes into account, the additional costs needed to further process and sell the joint products. Under this method, joint cost is allocated to products using the following formula:

Cost Allocated to a Joint Product =NRV the Product× Total Joint Costs
NRV of Total Production

Where NRV = Estimated Sales Value − Estimated Cost to Further Process and Sell

When such products are further processed after split-off, their total costs also include further processing cost.

Example

Use the following data relating to two chemicals A and B obtained from a joint process and allocate joint costs using each of the above methods.

ChemicalAB
Quantity (kg)80125
Sale Value$15,000$60,000
Further Processing Cost$4,000$2,000

Total manufacturing cost of joint process was $30,000.

Solution

Cost to be allocated to chemical A:

Physical Measurement Method30,000×80÷(80+125)11,707
Relative Sales Value Method30,000×15,000÷(15,000+60,000)6,000
NRV Method30,000×11,000÷(11,000+58,000)4,783

Where, 11,000 = 15,000 − 4,000 and 58,000 = 60,000 − 2,000

Now that we have estimated cost of Chemical A and there are just two products, we can calculate the cost to be allocated to chemical B just by subtracting the above costs from the total under each method respectively as shown below:

Cost to be allocated to chemical B:

Physical Measurement Method30,000−11,70718,293
Relative Sales Value Method30,000−6,00024,000
NRV Method30,000−4,78325,217

Written by Irfanullah Jan