What is Joint Cost?
Joint costs refer to the shared costs incurred during the production of multiple products or byproducts from a single production process. These costs are incurred up to a certain point where the products or byproducts diverge into their distinct forms. Joint costs are common in industries such as agriculture, manufacturing, and chemical processing, where a single raw material or production process results in multiple products with varying characteristics and values.
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The common costs associated with the combined process of production are called joint costs. The common costs are incurred up to the split-off point. A point where the joint products are split-off into individual products is called split-off point. Obviously, the common costs need to be allocated to individual products to have a fair assessment of cost to an individual product.
However, the allocation of joint costs to individual products is an issue of much concern to individual firms as there is no uniform policy for allocation of such costs. The individual firms adopt joint cost allocation policy as convenient to them, depending on their suitability.
Methods of Costing of Joint Products
The process of joint cost allocation involves assigning proportionate cost to individual products which is known as common cost and incurred while products were produced jointly. If this is not done, the concerning issue will be how to allocate the common costs. Not only this, we cannot determine the reasonable price of a product. It will have an impact on the valuation of inventory, profit forecasting and unreasonable costing and pricing of other products.
This issue should be managed in a proper way to overcome such problems. Therefore, the prime concern in respect of joint products remains adequate and proper allocation of the joint costs. In practice, there are different methods followed to allocate the joint costs. We discuss some of them in the following sections.
Average Cost Method
In this method the total costs are assessed and distributed in total number units. This gives an average unit cost with particular net profit for the total operations. However, this method could be used where processes are common and inseparable for the joint products. Also the products so received can be expressed in a common unit, say kilograms, numbers etc. Thus all joint products have the same unit cost.
The problem in this case may occur while fixing price based on the cost of various products where products may be of different variety, grades or quality. Since the costing system is common, the unit price will be uniform which will have practical implications. In addition to that if the final products are so that it cannot be expressed in common units, this method becomes inapplicable.
Physical Quantity Method
It is also known as physical unit method. In this method, a physical base, such as raw material, weight and volume, is applied in allocating commoncosts incurred before split-off point to joint products. We can consider an example of crude oil that has three common products, A, B and C, where proportion in production is 30%, 40% and 30%, respectively. While allocating joint costs, we will allocate the total joint costs in the same proportion.
After split-off points, each product may have separate costs. However in practice, there may be products with different measurements of units and in that case, it will not be possible to allocate joint costs under this method. Also, this method assumes that each joint product is equally valuable in terms of price and identity. The situation may not be true in all the cases. Therefore, this has a limitation to an extent.
This method is based on market survey of relative factors. We consider all the relative and important factors, like quantity, prevailing selling price, technical aspects, marketing process and other factors that affect costing of a product. This is done through an extensive market survey. We decide a percentage weight to be given to different products according to their utility and importance. The common costs are allocated based on those pre-decided weights.
If a firm feels that a particular product has more utility in generating its revenue, a higher percentage of weight could be considered. These weights are arbitrary and may have biasness. The firm also has the liberty to alter weights to different products depending on market trends from time to time. We cannot call this method as a rational method as it has biasness and the firm may take arbitrary decision, depending on its convenience.
Sales Revenue Method
This is one of the simplest methods where joint costs are allocated to different products based on the proportion of sales revenue of each product in total sales revenue. This is also known as market value method as this is a convenient approach.