Allocating Joint Costs
The term ‘joint costs’ is described as the total basic material cost and processing cost from which two or more distinct products are produced. The three key methods used to allocate joint costs are: Physical measures of output, relative sales value and net realizable value. All of the three approaches rely on the product outputs. The different approaches of allocating joint costs are as described below:
Physical measures of output allocate joint cost in proportion to the product output measure. This method relies on the physical quantity of the produced joint products at the split-off points (Hansen, 2017). The quantifiable characteristics commonly used include; length, weight, and liquid volume (Shukla et al., 2000). In comparison to other methods, physical measure of output is much simpler and easy to perform. However, the limitation the physical measures may not match joint product’s level of profitability.
In addition to the physical measure of output, relative sales value method allocates joint costs in proportion to the joint products’ total sales values at the split-off point. The advantage of this approach is that it provides accurate revenue figures of the joint products (Hansen, 2017). On the other hand, the limitation of this method is that the unavailability of sale prices at the split-off product due to lack of market.
The third approach of allocating joint costs is known as the net realizable value approach. Net realizable value approach allocates joint costs by estimating the value of sales at the split-off points. Net realizable value also refers to the difference between the total sales revenue and the separable costs (Shukla et al., 2000). The disadvantage of this method is that it often leads to inaccurate allocation of joint costs. This is because the revenue is always estimated. Additionally, the net reliable value may end up being negative thereby resulting to no allocation of the joint cost to the joint products.
In essence, I would recommend one to use the ‘relative sales value’ method as it directly allocates joint costs depending on the proportion total sales value of the joint products at the split-off point. This is a more accurate and realistic approach of allocating joint costs.
Shukla, M. C., Grewal, T. S., & Gupta, M. P. (2000). Cost Accounting: Text And Problems. Delhi: S. Chand & Co.
Hansen, D. O. N. R. (2017). Cornerstones of Cost Management. Place of publication not identified: South-Western.