By-Product, Joint, & Other Costing

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1 Question 1: What is joint product costing and by-products? Answer 1: A joint product cost is the cost of a production process that yields multiple products at the same time or produces a product that goes into multiple products. Joint costs are allocated to two or more products to do the following: compute inventory costs and cost of goods sold for financial accounting and internal reporting purposes. use cost reimbursement under contracts when only a portion of a business's products or services are sold or delivered to a specific customer or under a specific contract. The distinction between a joint product and a by-product is based on the sales value. A joint product is a product that has a high sales value. A by-product is a product that has a low sales value compared to the sales value of the joint products. By-product is produced from the scrap or waste of the joint product production. It is a product that would not be produced by the business if the joint products were not produced. It not only adds to the revenue of the business but, in many cases, prevents scrap material from going to landfills. Question 2: What are the most likely outputs of a joint process? What decisions must be made in this process? Answer 2: The most likely outputs of a joint process include the following: joint products with a relative high sales value by-products with a lower sales value scrap and waste with a very low sales value or no sales value There are four decisions that must be made in a joint product production process: Two are before the joint process is started, and two that are made at the splitoff point. Before the process is started, some steps must occur, including the following: 1

2 Management must estimate whether total revenues exceed total joint and separate costs combined. Management must decide whether this is the best use of available manufacturing resources. At the splitoff point, management must decide which products will be classified as joint products, by-products, scrap, and waste. decide which products will be sold at the splitoff point and which will be processed further. Question 3: What two common methods are used to allocate joint cost? Answer 3: The two most common methods used to allocate joint costs are a physical measure or a monetary measure. The physical measure determines what the output will be over time and calculates a cost per unit of product resulting from the joint process. The monetary measure takes into consideration the different valuations of the individual joint products based on sales value at the splitoff point and allocates the joint cost based on this value. Question 4: How are by-products and scrap values determined? Answer 4: By-products and scrap values are determined by using one of two methods: net realizable value (NRV) or realized value. The net realizable value method reduces the cost of the joint products by offsetting the cost of the work-in-process inventory of the joint products or by lowering the cost of goods sold of the joint products. The realized value method reports the sale of the by-products or scrap as other income on the income statement, thereby increasing the business revenue. Question 5: Why are manufacturing overhead costs allocated to products 2

3 based on a predetermined rate? Answer 5: Manufacturing overhead costs are allocated to products to more accurately cost individual products or groups of product. This allows an organization's management to have a clearer picture of the profitability of each product or group of products. to allocate manufacturing overhead costs to products based on the cost used by the product in the manufacturing area. to provide managers with cost information more readily than if they had to wait for actual cost information. Question 6: What is underapplied and overapplied manufacturing overhead? Answer 6: Underapplied manufacturing overhead occurs when actual overhead costs are greater than the estimated or budgeted manufacturing overhead in which the predetermined overhead allocation rate was based. This would indicate that the manufacturing process is not operating as efficiently as planned. Management would review this result and take corrective action. Overapplied manufacturing overhead occurs when actual overhead costs are less than the estimated or budgeted manufacturing overhead in which the predetermined overhead allocation rate was based. This would indicate that the manufacturing process is operating more efficiently than planned. At the closing of each accounting period, an adjusting entry is made to correctly cost the overhead cost for the accounting period. The cost accountant would create an adjusting closing entry in the appropriate journal accounts. Question 7: How do flexible budgets help managers calculate predetermined overhead rates? Answer 7: They allow managers to separate mixed costs into their variable and fixed components. They allow managers to understand what happens to costs (variable, 3

4 fixed, or mixed) at different levels of manufacturing volume. They provide information to managers on the budgeted costs to be incurred at different levels of manufacturing activity. This is a valuable tool for management decision making. Question 8: How is income calculated when using absorption costing and when using variable costing? Answer 8: In absorption costing, fixed costs are written off as a function of the number of units sold. If production volume is higher than sales volume, some fixed costs will be deferred in inventory until the inventory is sold. If sales volume is higher than production volume, the deferred fixed costs from previous periods will be written off as part of cost of goods sold. This would make the income lower than under variable costing. In variable costing, all fixed costs are written off in the period incurred, regardless of when the products produced are sold. If production volume is higher than sales volume, all fixed manufacturing costs will be expensed in the current period and will not be deferred until the produced products are sold, making income lower than under absorption costing. If production volume is lower than sales, only current period fixed manufacturing costs will be expensed in the current period, making income higher than under absorption costing. Absorption costing is used for financial reporting (income statements) as required by generally accepted accounting principles (GAAP), which are established by the Financial Accounting Standards Board (FASB) and the Securities and Exchange Commission (SEC) rulings. Variable costing is used internally for management decision making and control. Question 9: How do batch or job order costing methods differ from process costing methods? Answer 9: Batch or job order costing methods are used in businesses that make limited quantities of custom products for specific customers, whereas process costing is used in businesses that manufacture large quantities of like products on a continuous process for many customers. 4

5 Direct labor, materials, and overhead are applied specifically to each custom order. They do not calculate cost per unit like processing costing and may use an actual based costing system instead of a standard based costing system. Question 10: What are the most common reporting forms used in batch or job? What journal entries are generated by these forms? Answer 10: The most common reporting forms used include the following: Job order cost sheets serve as the work-in-process inventory subledger and are used to create work-in-process inventory journal entries. Purchase orders or material requisition forms trace the issuing of raw materials to the specific job and are used to account for raw material purchases and to generate journal entries for raw material. Employee time sheets record the hours worked and jobs worked on by employees to determine direct labor costs for each batch or job and journalize the direct labor cost. 5

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