Split off method of joint cost accounting

5 Joint Cost Allocation and Variable and Absorption Costing

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Learning Objectives

After studying Chapter 5, you will be able to:

• Use three different methods to allocate joint product costs, and explain how to handle situations involving byproducts and scrap.

• Recast absorption costing income statements into variable costing income statements, reconcile the differences between the two net incomes, and understand arguments supporting both approaches.

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Should We Hide the Joint Cost Assigned to Hides?

Toco Hills Meat Packers handles the slaughtering, processing, packaging, and distribution of cattle. Dianne Leader, the company’s President, has just received the first quarter financial statements from her Vice-President and Controller, Bruce Berger. She immediately sees that while profits from the various meat products are up from the previous quarter, the profits from hides are down considerably. She calls Bruce and asks, “Can you tell me why costs for the hides appear to be so high?” Bruce responds, “No, but I’ll look into it and get an answer for you by tomorrow at this time.”

Like clockwork, Bruce knocks on the President’s door, enters, and hands Dianne a one-page report. “Ah, the joint cost allocation to hides seems to be out of line,” Dianne says with a frown. “You know,” Dianne tells Bruce, “if I had to bet on it, I’d wager some big bucks that you changed the way joint costs are assigned to our products.”

Indeed, the way joint costs are assigned to joint products that are produced by a company can greatly affect the reported profits from the various products. So, how should these costs be assigned?

Chapter Outline

5.1 Joint Cost Allocation Physical Measures of Output Relative Sales Value Net Realizable Value Byproducts and Scrap

5.2 Variable and Absorption Costing Characteristics of Variable and Absorption Costing Comparing Variable Costing and Absorption Costing Reconciliation of Variable and Absorption Costing Arguments for Either Costing Method Effects of New Manufacturing Environments

5.1 Joint Cost Allocation Production processes can sometimes spawn multiple products from common inputs and pro- cessing. These are called joint products. An example is a refinery where crude oil is pro- cessed into joint products of gasoline, heating oil, and motor oil. The costs of materials and processing up until individual products are identifiable are referred to as joint costs. This point at which the individual products become identifiable is known as the split-off point. Until this point, the common input is a single product. The joint costs are allocated to the joint products for some product costing purposes such as external financial statement presenta- tion and product pricing. In previous chapters, we have allocated costs using cost drivers

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Section 5.1 Joint Cost Allocation

that measure inputs such as labor hours or machine hours. However, input measures are not feasible for allocating joint costs since the joint products are not individually distinguishable until the split-off point, and hence, one cannot identify the amount of input associated with each product that emerges at the split-off point. Three common joint cost allocation meth- ods—all based on outputs—are discussed next.

Physical Measures of Output Physical measures of output reflect some quantifiable physical characteristics of the joint products. Examples include number of units, weight, liquid volume, and length. The joint costs would be allocated in proportion to each product’s output measure. Consider the Vexler Min- ing Company, which mines ore, and after separating the ore in a smelter, sells the individual outputs to jewelry and industrial manufacturers. Suppose that $400,000 in materials, labor, and overhead was incurred to mine a total of 100,000 ounces of the following three metals:

Mineral Amount

Gold 10,000 ounces

Silver 20,000 ounces

Copper 70,000 ounces

100,000 ounces

The joint cost allocations are made by multiplying the ratio of the metal’s output to the 100,000 total and multiplying the ratio by the $400,000 joint cost, as follows:

Allocation to gold: (10,000 ÷ 100,000) × $400,000 = $40,000

Allocation to silver: (20,000 ÷ 100,000) × $400,000 = $80,000

Allocation to copper: (70,000 ÷ 100,000) × $400,000 = $280,000

Note that the sum of these three allocated costs equals the $400,000 total joint cost. This method is generally simple to use, but has two potential major drawbacks. First, the outputs may have different units of measure. For instance, consider a petroleum refinery that pro- duces gasoline and paraffin from a joint process. A common measure for gasoline, a liquid, would be gallons; for paraffin, a solid, a common measure would be pounds.

A second limitation is that physical measures may be unrelated to the profitability of the joint products. Why is this an important consideration? The reason relates to why joint costs are incurred. Since joint costs are incurred because of the value that will be received from selling the joint products, the allocation of these joint costs should be related to the products’ values. For Vexler Mining Company, 70% of the joint cost was allocated to copper. Suppose, however, that gold accounts for 90% of the three metals’ total revenues. Clearly, the gold is what moti- vates Vexler to spend $400,000 to mine the ore, yet it receives only 10% (10,000 ÷ 100,000) of the joint costs, while copper is charged with seven times as much.

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Section 5.1 Joint Cost Allocation

Relative Sales Value The relative sales value (RSV) approach allocates joint costs in proportion to the joint prod- ucts’ total sales values at the split-off point. Assume the following sales values for Vexler Min- ing Company’s joint products:

Mineral Sales Values

Gold $500,000

Silver 200,000

Copper 100,000

$800,000

Under the RSV method, the joint cost allocations would be as follows:

Allocation to gold: ($500,000 ÷ $800,000) × $400,000 = $250,000

Allocation to silver: ($200,000 ÷ $800,000) × $400,000 = $100,000

Allocation to copper: ($100,000 ÷ $800,000) × $400,000 = $50,000

Note that the sum of these three allocated costs equals the $400,000 total joint cost.

Net Realizable Value A potential problem with the RSV approach is that sales prices at the split-off point may not be readily available. Moreover, there might not even be a market for one or more of the joint products at the split-off point. Further processing may be necessary to sell some products. The net realizable value (NRV) method uses approximations of sales values at the split-off point. NRV is the total sales revenue of the product in its final form less any separable costs. The latter consist of costs incurred after the split-off point, and as such, can be traced to the individual products. Separable costs include processing costs, selling costs, and disposal costs.

Suppose that after Vexler Mining Company smelts its ore, it incurs some costs to get the met- als ready for sale to manufacturers. These separable costs, the products’ revenues, and the resulting NRVs are as follows:

Mineral Separable Costs Revenues NRV

Gold $10,000 $550,000 $540,000

Silver 12,000 252,000 240,000

Copper 15,000 135,000 120,000

$900,000

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Section 5.1 Joint Cost Allocation

For the NRV method, the joint cost allocations would be as follows:

Allocation to gold: ($540,000 ÷ $900,000) × $400,000 = $240,000

Allocation to silver: ($240,000 ÷ $900,000) × $400,000 = $106,667

Allocation to copper: ($120,000 ÷ $900,000) × $400,000 = $53,333

Note that the sum of these three allocated costs equals the $400,000 total joint cost. Occasion- ally, a situation may arise where a product’s NRV is negative. When this happens, none of the joint cost should be allocated to that product. The total joint cost would just be allocated to the products having positive NRVs.

The following table summarizes the joint cost allocations for all three methods:

Mineral Physical Output RSV NRV

Gold $40,000 $250,000 $240,000

Silver 80,000 100,000 106,667

Copper 280,000 50,000 53,333

$400,000 $400,000 $400,000

Byproducts and Scrap Byproducts and scrap are products that emerge with joint (main) products but have minor sales value compared to the joint products. Byproducts are often processed after the split- off point, while scrap is usually discarded. The accounting treatment, though, is the same for both byproducts and scrap. Joint costs are not allocated to byproducts or scrap. The rationale for this treatment is that joint costs are incurred to produce the main products—not byprod- ucts or scrap.

Revenue from byproducts or scrap is usually handled in one of two ways:

1. Recognize miscellaneous income from the NRVs of byproducts and scrap. 2. Deduct the NRVs of byproducts and scrap from the joint costs that are allocated to the

main products.

The rationale for the second approach builds on the argument we mentioned for not allocat- ing joint costs to byproducts or scrap. That is, the joint production process is undertaken for the profits to be earned from main products—not byproducts or scrap. Therefore, no profit should be recognized on byproducts or scrap. In effect, the second method shifts any profit (NRV) on byproducts and scrap to the main products by reducing the joint costs assigned to the main products.

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Section 5.2 Variable and Absorption Costing

As an example, suppose that sulphur is a byproduct at Vexler Mining Company. Recall that with the RSV method, we had the following RSVs for the three joint products:

Mineral Sales values

Gold $500,000

Silver 200,000

Copper 100,000

$800,000

Suppose now that sulphur could be sold at the split-off point for $8,000 after incurring sepa- rable costs of $2,000. With the miscellaneous income approach, $6,000 ($8,000 – $2,000) in miscellaneous income would appear on Vexler’s income statement from the sale of sulphur. Under the alternate approach, joint costs of $394,000 ($400,000 – $6,000) would be allocated to the main products in proportion to just the main products’ total sales values, as follows:

Allocation to gold: ($500,000 ÷ $800,000) × $394,000 = $246,250

Allocation to silver: ($200,000 ÷ $800,000) × $394,000 = $98,500

Allocation to copper: ($100,000 ÷ $800,000) × $394,000 = $49,250

5.2 Variable and Absorption Costing Variable costing (also known as direct costing) is an approach to product costing that assigns only variable manufacturing costs (direct materials, direct labor, and variable factory overhead) to items produced. Thus, inventoriable costs are limited to the variable manufac- turing costs, and period costs include all fixed costs and variable nonmanufacturing costs. Absorption costing (also known as full costing), the method typically used for external income statement reporting, allocates all manufacturing costs (variable and fixed) to prod- ucts. This section compares these two costing methods.

Contemporary Practice 5.1: Usage of Variable Costing

In a survey of 148 German and 130 U.S. companies in a cross section of industries, far more German companies labeled their costing system as variable costing—52% versus 21%. The director of cost accounting and internal audit at Cliffstar remarked, “We like variable costing because it doesn’t ‘muddy up’ the waters with less controllable fixed overhead.”

Source: Krumwiede, K., & Suessmair, A. (2007, June). Getting down to specifics on RCA. Strategic Finance, 51–55.

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Section 5.2 Variable and Absorption Costing

Variable costing, like absorption costing, can be used in conjunction with actual, normal, or standard costing systems. For simplicity, we will restrict our discussion in this chapter to situ- ations in which actual costing is used.

Characteristics of Variable and Absorption Costing The two costing methods vary as to the cost elements for product costs, the difference in inventory values, and the difference in profits. These differences all result from one basic item—the treatment of fixed manufacturing costs. Absorption costing includes these costs in product costs while variable costing considers them as period costs to be included with the operating expenses. The following summary contrasts the two costing approaches:

Cost Category Variable Costing Absorption Costing

Direct materials Product Product

Direct labor Product Product

Variable factory overhead Product Product

Fixed factory overhead Period Product

Marketing expenses Period Period

Administrative expenses Period Period

Variable costing typically uses a contribution margin approach as a reporting format. Vari- able marketing and administrative costs are included in the computation of the contribution margin. However, variable marketing and administrative costs are not product costs. While we will portray variable costing income statements using the contribution format, we will use the traditional format for the absorption costing income statements. A comparison of the two approaches appears below:

Variable Costing Absorption Costing

Sales revenue Sales revenue

− Variable cost of goods sold − Cost of goods sold

− Other variable costs = Gross profit

= Contribution margin − Other variable costs

− Fixed manufacturing costs − Fixed manufacturing costs

− Fixed nonmanufacturing costs − Fixed nonmanufacturing costs

= Operating income = Operating income

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Section 5.2 Variable and Absorption Costing

Deciding between variable costing and absorption costing has an impact on inventory val- ues and profits because of the variation in the treatment of fixed factory overhead. Although the profit can differ between the two costing methods, profit under variable costing is not always higher or lower than absorption costing. The difference between profits under the two methods is determined by the relationship of production to sales. Assuming that the fixed manufacturing costs per unit remain the same from one period to the next, we have three pos- sibilities, as follows:

Net Income

Production units equal sales units AC = VC

Production units greater than sales units (building inventory)

AC > VC

Production units less than sales units (liquidating inventory)

AC < VC

AC = Absorption costing VC = Variable costing

The magnitude of any difference in profits is a function of the fixed manufacturing costs per unit and the changes in inventory levels, as we will discuss later.

Comparing Variable Costing and Absorption Costing Let’s assume that Morris the Florist sells one type of floral arrangement. In its first year, 2018, Morris the Florist produced 100,000 arrangements and sold 75,000 at $25 each. The costs for the year are:

Production Costs (Per Unit):

 Materials $3.00

 Labor  8.00

 Variable overhead  5.00

 Fixed overhead ($200,000/100,000 units)  2.00

Marketing and Administrative Costs:

 Variable $1.00 per unit sold

 Fixed $150,000

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Section 5.2 Variable and Absorption Costing

The absorption costing income statement that reflects these results is as follows:

Absorption Costing Income Statement for the Year Ended December 31, 2018

Sales revenue ($25 × 75,000) $1,875,000

Cost of sales:

Variable ($16 × 75,000) $1,200,000

Fixed ($2 × 75,000) 150,000 1,350,000

Gross profit $525,000

Marketing and administrative expenses:

Variable ($1 × 75,000) $75,000

Fixed 150,000 225,000

Net profit $300,000

A variable costing income statement would be as follows:

Variable Costing Income Statement for the Year Ended December 31, 2018

Sales revenue ($25 × 75,000) $1,875,000

Variable costs:

Production ($16 × 75,000) $1,200,000

Marketing and administrative ($1 × 75,000) 75,000 1,275,000

Contribution margin $600,000

Fixed costs:

Production $200,000

Marketing and administrative 150,000 350,000

Net profit $250,000

Notice that the variable costing profit is lower than the profit from absorption costing. Why does this happen? The next section answers this question.

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Section 5.2 Variable and Absorption Costing

Reconciliation of Variable and Absorption Costing The difference in net profit figures between absorption costing and variable costing is due solely to the treatment of fixed production costs. Absorption costing includes those costs in the inventory costs; variable costing treats them as expenses to be charged to the period incurred. During any given time period, the amount of fixed costs in inventory will increase or decrease as production differs from sales. If production is greater than sales (as is the case with Morris the Florist in 2018), fixed costs in the ending inventory are deferred to future periods under absorption costing. That is, fixed costs are treated as assets by including them as part of inventory, and they will be moved to the income statement as cost of goods sold when sold. Alternatively, all fixed costs are expensed under variable costing. Therefore, absorption costing will show a higher net profit. Conversely, if sales are greater than produc- tion, fixed costs in the beginning inventory are expensed in the current period and added to the fixed costs incurred during the current period. Therefore, fixed costs in the income state- ment under absorption costing are higher than under variable costing, and the result is a lower net profit for absorption costing.

In the simplified case in which fixed overhead costs per unit are the same in beginning and ending inventories, the difference in net profits is exactly equal to the change in inventory units times the fixed overhead rate per unit. For Morris the Florist, the change in inventory is:

Units produced 100,000

Units sold 75,000

Increase in inventory 25,000

Using a fixed overhead rate of $2 per unit, the difference in net profits is: $2 × 25,000 units = $50,000. Let’s check this result:

Absorption costing net profit $300,000

Variable costing net profit 250,000

Difference $50,000

When the fixed overhead rates are different in beginning and ending inventories, the recon- ciliation of net profit figures is performed as follows:

Absorption costing net profit

+ Fixed overhead in beginning inventory

– Fixed overhead in ending inventory

= Variable costing net profit

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Section 5.2 Variable and Absorption Costing

To illustrate, suppose that in 2019, Morris the Florist produces 80,000 floral arrangements and sells 100,000. We will presume the same total fixed costs, unit variable costs, and selling price as in 2018. Morris the Florist uses a FIFO cost flow. As a result, the fixed overhead per unit produced during 2019 is $2.50 ($200,000/80,000).

The 2019 absorption costing income statement would be as follows:

Absorption Costing Income Statement for the Year Ended December 31, 2019

Sales revenue ($25 × 100,000) $2,500,000

Cost of sales:

Variable ($16 × 100,000) $1,600,000

Fixed [($2 × 25,000) + ($2.50 × 75,000)] 237,500 1,837,500

Gross profit $ 662,500

Marketing and administrative expenses:

Variable ($1 × 100,000) $100,000

Fixed 150,000 250,000

Net profit $412,500

Note that the fixed portion of cost of sales is consistent with the FIFO cost flow assumption. The first 25,000 units come from 2018 production, which had a unit cost of $2 for fixed over- head; the remaining 75,000 units come from 2019 production, which had a unit cost of $2.50 for fixed overhead.

The 2019 variable costing income statement would be as follows:

Variable Costing Income Statement for the Year Ended December 31, 2019

Sales revenue ($25 × 100,000) $2,500,000

Variable costs:

Production ($16 × 100,000) $1,600,000

Marketing and administrative ($1 × 100,000) 100,000 1,700,000

Contribution margin $ 800,000

Fixed costs:

Production $200,000

Marketing and administrative 150,000 350,000

Net profit $450,000

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Section 5.2 Variable and Absorption Costing

We reconcile the 2019 net profits as follows:

Absorption costing net profit $412,500

+ Fixed overhead in beginning inventory ($2 × 25,000) 50,000

– Fixed overhead in ending inventory ($2.50 × 5,000) (12,500)

= Variable costing net profit $450,000

The reconciliation of net profits between the two costing methods is independent of inven- tory cost flow assumptions. A company can use FIFO, LIFO, or some average cost method; the reconciliation of net profits follows the same procedures.

Another observation about the difference between the two methods relates to the profit pat- terns over time with respect to production and sales strategies. Let’s consider the case of a constant production schedule over time while sales fluctuate each period. The absorption costing net income will fluctuate up and down with sales, but the constant production will have a leveling effect on the swings. The peaks will not be as high nor as low as the corre- sponding sales changes. Variable costing net income, on the other hand, will have swings that match those of sales, in both direction and relative magnitude. For the situation where pro- duction fluctuates while sales remain rather constant, a different picture appears. Absorption costing net income will fluctuate with production, in both direction and relative magnitude. Variable costing net income will remain constant, corresponding with sales levels.

While absorption and variable costing methods yield different profit figures during periods when units sold do not equal units produced, these are timing differences. If over the course of several time periods, aggregate production equals aggregate sales, then the aggregate prof- its will be the same for both costing methods despite differences in profits during specific periods.

Arguments for Either Costing Method Neither variable costing nor absorption costing is correct or incorrect. Their usefulness cor- relates with management’s attitudes and with philosophies of organizational behavior. Some companies will find variable costing extremely useful, while other companies will find it less meaningful. Any manager can make a valid case for either variable or absorption costing. The primary arguments, for and against, are discussed next.

Short Term Versus Long Term. Those who favor variable costing—let’s call them the “vari- able costers”—believe it focuses on the short-term consequences of accounting and is more realistic of the way managers make decisions. Those who favor absorption costing—let’s call them the “absorption costers”—assume that long-run performance is more important and that absorption costing more appropriately reflects long-term consequences.

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Section 5.2 Variable and Absorption Costing

Unethical Behavior By Managers. Variable costers assume that managers can easily adapt to a new accounting method with little additional cost. They further argue that managers will be rewarded for playing games with absorption costing reports. They specifically refer to a manager’s ability to manipulate net profit by increasing or decreasing inventory levels that are valued under absorption costing. As we have seen, inflating inventories reduces current period expenses with absorption costing and reducing inventories would increase current period expenses with absorption costing. Managers’ evaluations and bonuses that are based on net profits can therefore be impacted by these actions relating to inventories. The absorp- tion costers admit that occasional short-term decisions (e.g., amount of ending inventory to hold) will be made incorrectly. However, over the long term, the mistakes will be more obvi- ous, and the “games” will be discovered by competent superiors. Absorption costers might assert that unethical managers cannot be suddenly rehabilitated by a change in accounting methods.

Variable Versus Fixed Costs. Variable costers believe that costs can be easily and meaning- fully divided into variable and fixed categories and that using a contribution margin is much more useful for planning and decision making and for control and performance evaluation. Since absorption costing is primarily for external reporting purposes, absorption costers do not see this distinction as meaningful for reports. They will also argue that managers can still make the cost behavior distinctions for internal purposes. They also point out that the vari- able/fixed split is not easily made in practice.

External Versus Internal Reports. Financial statement reporting using generally accepted accounting principles, as well as tax reporting for the Internal Revenue Service, require absorption costing. Variable costers argue that allowing external reporting requirements to dominate how useful and meaningful information should be reported is not a valid philoso- phy for competent management. Since information should be geared to the needs of man- agement, external requirements should not drive the internal accounting system. Absorption costers argue that to have one set of requirements for external reporting and another set for internal reporting gives managers conflicting and inconsistent information. It also forges an image that the company is hiding something in the two approaches.

Effects of New Manufacturing Environments Since the major variation between the two methods is the treatment of fixed costs as product or period costs, the difference in net profits disappears when little or no inventory of work in process or finished goods exists. For companies implementing JIT production procedures, inventories will be eliminated or substantially reduced. Hence, the particular costing method chosen loses significance in this environment. Also, this controversy is irrelevant to service organizations that do not carry inventories.

In automated production environments, whether JIT or not, the bulk of labor and factory overhead costs is fixed. Variable costs represent a low percentage of total manufacturing costs. In these environments, therefore, variable costing loses much of its appeal because the product cost will be a small fraction of the total manufacturing cost.

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Summary & Resources

Summary & Resources

Chapter Summary Joint costs are allocated to joint products using either physical measures of output, the relative sales value method, or the net realizable value method. No joint costs are allocated to byprod- ucts or scrap, and their net realizable values are either treated as miscellaneous income or as deductions from the costs allocated to the main products.

Variable costing includes only variable manufacturing costs as an element of product cost. The traditional method of income statement preparation is called absorption costing. It includes fixed manufacturing costs as an element of product cost. As a result of this difference, net profit under the two methods will not necessarily be the same. Anytime production exceeds sales, absorption costing yields a higher net profit; when sales exceeds production, variable costing yields a higher net profit. The arguments for and against using either costing method apply to individual situations and management philosophy. Neither method is inherently cor- rect or incorrect.

Key Terms absorption costing A product costing method that allocates all manufacturing costs (variable and fixed) to products.

byproducts Products produced from a joint manufacturing process that have minor sales value and are typically processed further beyond the split-off point.

direct costing A product costing method that allocates only variable manufacturing costs to items produced.

full costing A product costing method that allocates all manufacturing costs (variable and fixed) to products.

joint costs The costs of materials and processing common to the production of multiple products that emerge from the joint production process.

joint products The products that emerge from a process where there are common inputs so that the individual products are initially indistinguishable.

net realizable value (NRV) The total sales revenue from the final product less its total separable costs.

relative sales value (RSV) An approach that allocates joint costs based on revenues that can be received from selling the prod- ucts at the split-off point.

scrap Products produced from a joint manufacturing process that have minor sales value and are not processed further beyond the split-off point.

separable costs Costs incurred beyond the split-off point.

split-off point The point in the joint pro- duction process at which the individual products can be identified.

variable costing A product costing method that allocates only variable manufacturing costs to items produced.

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Summary & Resources

Problem for Review Ludwig’s Plumbing Products purchases raw materials and processes them into more refined products. In July, Ludwig’s purchased raw materials for $40,000. Conversion costs of $60,000 were incurred up to the split-off point, at which time two salable products were produced: Product A and Product B. Product B can be further processed into Product C. The July produc- tion and sales data were:

Production Sales Sales Price

Product A 1,200 tons 1,200 tons  $50 per ton

Product B   800 tons

Product C   500 tons   500 tons $200 per ton

All 800 tons of Product B were further processed, at an incremental cost of $20,000, to yield 500 tons of Product C. There were no byproducts or scrap from this further processing of Product B.

There is an active market for Product B. Ludwig’s could have sold all of its July production of Product B for $75 per ton.

Questions:

1. Allocate the joint costs using the relative sales value method. 2. Allocate the joint costs using the physical measures method. 3. Allocate the joint costs using the net realizable value method.

Solution:

1. RSV method:

RSV of Product A = 1,200 × $50 = $60,000

RSV of Product B = 800 × $75 = $60,000

The total joint cost of $100,000 ($40,000 + $60,000) would be allocated equally to each of Products A and B (i.e., $50,000 to each).

2. Physical measures method:

Allocation to Product A = (1,200 / 2,000) × $100,000 = $60,000

Allocation to Product B = (800 / 2,000) × $100,000 = $40,000

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Summary & Resources

3. NRV method:

NRV of Product A = 1,200 × $50 = $60,000

NRV of Product B = (500 × $200) – $20,000 = $80,000

Allocation to Product A = ($60,000 / $140,000) × $100,000 = $42,857

Allocation to Product B = ($80,000 / $140,000) × $100,000 = $57,143

Questions for Review and Discussion

1. What are the two criticisms of allocating joint costs based on physical measures of output?

2. Explain the practical problem that sometimes prevents the use of the relative sales value method.

3. Differentiate between variable costing and absorption costing. 4. How is it possible to increase net profit using absorption costing when sales are not

increasing? 5. A company had a highly labor-intensive manufacturing process. Recently it imple-

mented robotics and a number of other technological changes that made the process capital intensive. What impact would these changes make on the inventory valua- tions for variable costing and for absorption costing?

Exercises

5-1. Joint Costs Allocated to Services. Randy Gold & Associates, a CPA firm, provides audit, tax, and consulting services. The firm spent $800 recruiting a particular client, George Gottlieb, who contracted for all three services after a round of golf, a sumptu- ous meal, and a bottle of fine wine. After the firm’s work for Gottlieb was completed, the following information was available:

Service Fees Charged

Traceable Costs

Labor Overhead

Audit $14,000 $5,200 $4,000

Tax 10,000 3,000 2,300

Consulting 22,000 9,100 5,500

Question:

Using the NRV method, allocate the joint cost to the three services.

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Summary & Resources

5-2. Joint Cost Allocations and Ending Inventories. Falk Corporation crushes and refines mineral ore into three products in a joint operation. There were no beginning inventories of any products. Joint costs are $420,000, resulting in the production of 20,000 pounds of Adelia, 60,000 pounds of Dalewood, and 100,000 pounds of Bram- ble. Adelia is processed further at a cost of $100,000, and Dalewood is processed further at a cost of $200,000. Bramble does not require any further processing.

The results for the current year are:

Adelia: 19,000 lbs. sold at $20/lb. Dalewood: 58,000 lbs. sold at $6/lb. Bramble: 95,000 lbs. sold at $1/lb.

Question:

Determine the cost of the ending inventories using the NRV method to allocate joint costs.

5-3. Joint Cost Allocation and Income Statements. Lowenstein Promotions, Inc. produces rock concerts across the country. A recent concert by the Twins was also recorded as a CD. The live concert attracted 9,000 people who paid $35 per ticket, and the CD is projected to sell 26,000 units at $11 each. Joint costs of the concert and CD amounted to $300,000. Separable costs are $2 per ticket and $3 per unit for the CDs.

Questions:

1. Comment on the feasibility of allocating the joint costs based on physical measures. 2. Using the NRV method, compute the amount of joint costs to allocate to the live con-

cert and to the CDs. 3. Prepare product-line income statements for the live concert and for the CDs.

5-4. Joint Cost Allocation With a Byproduct. Paul Fay Fisheries spent $11,000 to catch 3,000 pounds of tuna, 12,000 pounds of shellfish, and 500 pounds of various other fish during July. The tuna was sold to Shinderman Industries for $8,000, and the shellfish was sold to Lisa’s Diner for $17,000. The other fish was converted to fish oil, which is treated as a byproduct. Separable costs amounted to $200 for the fish oil, which was sold to Jake’s Food Products for $900. Paul Fay Fisheries uses physical output to allocate joint costs.

Questions:

Explain how the NRV from the byproduct would be treated and determine the joint cost allo- cations for each of the following two alternatives:

1. Miscellaneous income approach 2. Reduction of joint cost approach

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Summary & Resources

5-5. Absorption Costing. Leff Corporation incurred the following costs during the year:

Direct materials $10,000

Direct labor 30,000

Other costs: Variable Fixed

 Manufacturing $15,000 $25,000

 Marketing 5,000 2,000

Administrative 1,000 6,000

Question:

Under absorption costing, determine the amount that would be classified as product costs.

5-6. Determining Ending Inventory. Goldie Industries uses an absorption costing sys- tem. The following data pertain to June:

Operating income $70,000

Beginning inventory 12,000 units

Fixed overhead application rate $2 per unit (May and June)

Joe Pearl, the owner, has determined that the operating income would be $90,000 under variable costing.

Question:

How many units are in the June ending inventory?

5-7. Inventory and Cost of Goods Sold. Karchava Industries is headquartered in Tbilisi, Republic of Georgia, and has three manufacturing plants near the Black Sea. Nino Aladashvili, the company’s cost accountant, reports the following data for October:

Units: Beginning inventory 135,000

Production ?

Sales 250,000

Ending inventory 142,000

Costs (in lari): Beginning inventory 7,000,000

Variable manufacturing costs 19,000,000

Fixed manufacturing costs 8,000,000

Variable selling & administrative costs 9,000,000

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Questions:

1. Compute the unit cost of the inventory produced during October using variable costing.

2. Compute the unit cost of the inventory produced during October using absorption costing.

3. If the company uses absorption costing and assumes a FIFO cost flow, what is the cost of goods sold for October?

5-8. Variable Costing Income Statement. Nahmias Bee Hives produces honey for sale to various food manufacturers. The income statement for last year, prepared on an absorption costing basis, is as follows:

Number of containers produced and sold 250,000

Sales revenue $2,000,000

Cost of goods sold 1,500,000

Gross profit $ 500,000

Operating expenses (includes variable costs of $125,000) 225,000

Profit before income taxes $ 275,000

Income taxes 110,000

Profit after income taxes $ 165,000