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Chapter 16: Problem 14

Describe two major methods to account for byproducts.

Short Answer

Expert verified
The two major methods to account for byproducts in cost accounting are the Sales Method and the Production Method. The Sales Method, or Byproducts Credited to Cost of Production Method, credits the revenue from the sale of byproducts to the main product's production cost, thus reducing the overall cost of production. The process involves determining total production costs, calculating revenue generated from byproducts, deducting the revenue from total production costs, and allocating the adjusted production costs to the main product. The Production Method, or Byproducts Inventoried Method, recognizes byproducts as inventory and allocates their costs based on the cost of producing the main product. This involves determining the total production costs of the main product and byproducts, allocating costs between them, recording the cost of byproducts as inventory on the balance sheet, and eventually recognizing the value of byproducts as revenue when they are sold.

Step by step solution

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1. Introduction to Byproducts Accounting

Byproducts are secondary products that result from the production process of a primary product. In cost accounting, it is important to account for these byproducts to determine the total cost of the primary product and allocate costs accordingly. There are two major methods used in accounting for byproducts - the Sales Method and the Production Method. We will explore each method separately.
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2. The Sales Method

The sales method, also known as the Byproducts Credited to Cost of Production Method, is an accounting technique in which the revenue derived from the sale of byproducts is credited to the cost of production of the main product. This method reduces the cost of production of the main product by considering the revenue generated from byproducts. The process can be divided into a few steps: Step 1: Determine the total production costs of the main product. Step 2: Calculate the revenue generated from the sale of byproducts. Step 3: Deduct the revenue from the byproducts from the total production costs of the main product. Step 4: Allocate the adjusted production costs to the main product. By using the Sales Method, the cost of production for the main product is reduced, which helps in determining the true cost of production, considering the value generated from the byproducts.
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3. The Production Method

The production method, also known as the Byproducts Inventoried Method, is an accounting technique in which the byproducts are recognized as inventory and their costs are allocated based on the cost of producing the main product. The byproducts are valued at either their net realizable value or their cost of production. Here are the steps involved in the Production Method: Step 1: Determine the total production costs of the main product and byproducts. Step 2: Allocate the costs between the main product and byproducts based on a predetermined basis such as the physical quantities produced, sales value, or net realizable value. Step 3: Record the cost of byproducts as inventory on the balance sheet. The cost of the main product would include the allocated cost of the byproduct. Step 4: When the byproducts are eventually sold, their value is recognized as revenue, and the corresponding inventory value is removed from the balance sheet. This method focuses on allocating the costs between the main product and byproducts appropriately and recognizing the value of byproducts when they are eventually sold. In conclusion, the two major methods to account for byproducts are the Sales Method and the Production Method. Both methods focus on different aspects, with the Sales Method reducing the production cost of the main product through byproducts revenue and the Production Method allocating costs between main product and byproducts and valuing byproducts as inventory.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

sales method
In cost accounting, the sales method offers a way to handle byproducts by giving them a clear financial role in the accounting process. This method is advantageous since it simplifies how byproducts influence the cost of the main product. Here's how it works:

The sales method takes the revenue from selling byproducts and uses it to decrease the cost of making the main product. This is why it's sometimes called the "Byproducts Credited to Cost of Production Method."

  • First, calculate the total production cost of the main product.
  • Next, account for any revenue made from selling byproducts.
  • Subtract this byproduct revenue from the total production costs to get the adjusted production cost of the main product.
  • The resulting figure, which is lower, represents a more accurate cost of producing the main product.
The major advantage of this method is its simplicity to implement and the clear reduction it offers on the production cost of the main product. However, it's important to note that this method does not assign any separate value to byproducts as inventory, which some may consider a drawback.
production method
The production method contrasts with the sales method by involving byproducts more directly in the accounting process. Here, byproducts are not just an afterthought but are treated as tangible inventory.

This approach is often referred to as the "Byproducts Inventoried Method." It steps away from directly reducing costs and instead focuses on cost allocation across products.

  • Firstly, determine the production costs for both the main product and the byproducts.
  • Allocate these costs between the main product and byproducts based on methods like physical quantities produced or net realizable value.
  • Treat byproducts as inventory, logging them on the balance sheet.
  • When sold, the inventory value of the byproducts recognizes revenue, and the inventory value is removed from the balance sheet.

This system ensures accurate cost allocation, reflecting the genuine economic contributions of both the main product and byproducts. The result? Byproducts are seen both as a cost and a future revenue source through their inventory status.
cost allocation
Cost allocation is a vital part of accounting that ensures expenses are fairly distributed across all products. When dealing with byproducts, cost allocation becomes critical in accurately reflecting the true cost and potential revenue.

Under both the sales method and production method, the approach to cost allocation varies:

- **Sales Method**: Here, byproduct revenue is used to diminish the production cost of the main product. While no specific cost is allocated directly to byproducts, this approach helps streamline costs.
- **Production Method**: This method allocates costs to byproducts, treating them as inventory. It is more conventional in accounting practices as it gives a more realistic economic portrayal of resource use.

Determining how costs should be allocated often depends on the business's nature and how it perceives the role of byproducts.
byproducts as inventory
Recognizing byproducts as inventory changes the perspective of how they contribute financially to a business. In essence, it gives them a more permanent place in accounting records.

By treating byproducts as inventory, they are granted a value that lasts until they are sold. This approach is used chiefly in the production method.

- **Inventory Treatment**: Byproducts are entered into the balance sheet as inventory. This recognizes them as assets with value that will eventually translate into revenue.
- **Future Revenue**: By having a recorded value, byproducts demonstrate potential future income when sold.

The key advantage is capturing the byproduct's value accurately, reflecting it as a future income source. This practice aligns well with companies seeking a comprehensive approach to cost accounting.

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Most popular questions from this chapter

Why is the constant gross-margin percentage NRV method sometimes called a "joint-cost-allocation and a profit-allocation" method?

The Seattle Recycling Company (SRC) purchases old water and soda bottles and recycles them to produce plastic covers for outdoor furniture. The company processes the bottles in a special piece of equipment that first melts, then reforms the plastic into large sheets that are cut to size. The edges from the cut pieces are sold for use as package filler. The filler is considered a byproduct. SRC can produce 25 table covers, 75 chair covers, and 5 pounds of package filler from 100 pounds of bottles. In June, SRC had no beginning inventory. It purchased and processed 120,000 pounds of bottles at a cost of \(\$ 600,000 .\) SRC sold 25,000 table covers for \(\$ 12\) each, 80,000 chair covers for \(\$ 8\) each, and 5,000 pounds of package filler at \(\$ 1\) per pound. 1\. Assume that SRC allocates the joint costs to table and chair covers using the sales value at splitoff method and accounts for the byproduct using the production method. What is the ending inventory cost for each product and gross margin for SRC? 2\. Assume that SRC allocates the joint costs to table and chair covers using the sales value at splitoff method and accounts for the byproduct using the sales method. What is the ending inventory cost for each product and gross margin for SRC? 3\. Discuss the difference between the two methods of accounting for byproducts, focusing on what conditions are necessary to use each method.

Distinguish between a joint product and a byproduct.

Provide three reasons for allocating joint costs to individual products or services.

(CMA, adapted) Newcastle Mining Company (NMC) mines coal, puts it through a one-step crushing process, and loads the bulk raw coal onto river barges for shipment to customers. NMC's management is currently evaluating the possibility of further processing the raw coal by sizing and cleaning it and selling it to an expanded set of customers at higher prices. The option of building a new sizing and cleaning plant is ruled out as being financially infeasible. Instead, Amy Kimbell, a mining engineer, is asked to explore outside-contracting arrangements for the cleaning and sizing process. Kimbell puts together the following summary: Kimbell also learns that \(75 \%\) of the material loss that occurs in the cleaning and sizing process can be salvaged as coal fines, which can be sold to steel manufacturers for their furnaces. The sale of coal fines is erratic and NMC may need to stockpile them in a protected area for up to one year. The selling price of coal fines ranges from \(\$ 14\) to \(\$ 25\) per ton and costs of preparing coal fines for sale range from \(\$ 3\) to \(\$ 5\) per ton. 1\. Prepare an analysis to show whether it is more profitable for NMC to continue selling raw bulk coal or to process it further through sizing and cleaning. (Ignore coal fines in your analysis.) 2\. How would your analysis be affected if the cost of producing raw coal could be held down to \(\$ 20\) per ton? 3\. Now consider the potential value of the coal fines and prepare an addendum that shows how their value affects the results of your analysis prepared in requirement 1.
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