A small business review of accounting for primary products, byproducts and scrap.Many small companies produce two or more primary products from a single process. In the agriculture industry, for example, crushing crushing deaths of newborn animals, especially those in litters, caused by the mother lying on them accidentally. Contributed to by weakness of the neonate or awkward accommodation. A problem in piglets and puppies. Called also overlying. soybeans produces soybean oil Soy´bean oil n. 1. an oil obtained from the soybean (Glycine max), rich in protein, fats, sterols, and phospholipids, used as a food and in paints and varnishes and in various industrial applications; - and soybean soybean, soya bean, or soy pea, leguminous plant (Glycine max, G. soja, or Soja max) of the family Leguminosae (pulse family), native to tropical and warm temperate regions of Asia, where it has been meal, two primary products. It is not uncommon for small companies to obtain both primary products and byproducts (products considered to be of minor importance by management) from a single process. Crushing soybeans, for example, also produces hulls, a byproduct by·prod·uct or by-prod·uct n. 1. Something produced in the making of something else. 2. A secondary result; a side effect. Noun 1. . Classifying products that come from a joint process as primary products or as byproducts is a management decision that most small businesses should review from time to time. In many cases, byproducts become more important over time and are reclassified by management as primary products. Pine pine, common name for members of the Pinaceae, a family of resinous woody trees with needlelike, usually evergreen leaves. The Pinaceae reproduce by means of cones (see cone) rather than flowers and many have winged seeds, suitable for wind distribution. bark bark, sailing vessel bark or barque (both: bärk), sailing vessel with three masts, of which the mainmast and the foremast are square-rigged while the mizzenmast is fore-and-aft-rigged. , for example, was once a byproduct for small sawmills and was left in piles piles: see hemorrhoids. for disposal when convenient. Today, however, pine bark is in great demand as landscaping mulch mulch, any material, usually organic, that is spread on the ground to protect the soil and the roots of plants from the effects of soil crusting, erosion, or freezing; it is also used to retard the growth of weeds. and many mills consider it to be a primary product. This article focuses on the accounting and management issues that small business should consider when classifying products--either as primary products or as byproducts--that come from a common process. Examples are provided for various methods that one might use to account for primary products and byproducts. DEFINITIONS Primary products are produced as a direct result of the strategic planning Strategic planning is an organization's process of defining its strategy, or direction, and making decisions on allocating its resources to pursue this strategy, including its capital and people. process of the company. These products are considered to be of major importance to the company and, therefore, represent a significant focus for management, accounting, and financial reporting. In this article, we focus on primary products that emerge from a common process. These products are also commonly referred to as joint products. Byproducts emerge from a common process along with primary products but are not considered to be important or valuable enough to be a major focus of management. Scrap is the residual Residual See:Residual value pieces/parts of material. Joint cost is the cost of raw materials and the processing cost incurred up to the point (split-off The process whereby a parent corporation organizes a subsidiary corporation to which it transfers part of its assets in exchange for all of the subsidiary's capital stock, which is subsequently transferred to the shareholders of the parent corporation in exchange for a portion of their point) where the primary products and byproducts are separately identifiable. Split-off point is the point in a common process where the separate primary products and byproducts emerge. There are major differences in how one accounts for primary products and byproducts. For accounting and internal reporting purposes, the cost of each primary product is separately determined and compared to the revenue from that product. The total cost of each of the separate primary products includes (1) an allocated portion of the joint cost, and (2) the cost associated with the primary product after the split-off point. The cost of soybean meal, for example, would include a portion of the cost of the soybeans themselves (joint cost), a proportion of the cost to crush crush A combination commodity trade in which soybean futures are purchased and soybean meal or oil futures are sold. Compare reverse crush. the soybeans (joint cost), and any cost to process the soybean meal after it has been crushed. Accounting for byproducts, on the other hand, reflects the minor role these products play. The cost of byproducts is usually not determined separately and, consequently, no joint costs are allocated to them. In general, the preferred accounting treatment is to subtract A relational DBMS operation that generates a third file from all the records in one file that are not in a second file. the proceeds (sales value) of the byproducts from the joint cost associated with them. In the soybean example, soybean meal and soybean oil are considered to be primary products and hulls are considered to be a byproduct. Using the preferred accounting method, the proceeds from the sale of the byproduct (hulls) are used to reduce the cost of the soybeans originally purchased (joint cost). The newly computed joint cost is allocated to soybean meal and soybean oil (primary products) as noted above. PRIMARY PRODUCTS A number of methods are used to allocate To reserve a resource such as memory or disk. See memory allocation. joint cost to the separate primary products produced from a common process. Here we illustrate the physical measures method, the value at split-off point method, and the constant gross-profit percentage method. Example Data: The Alpha Company purchased 1,000 bushels of soybeans (60 lbs per bushel bushel: see English units of measurement. ) for $7 per bushel. Each bushel of soybeans is crushed into 49 lbs of soybean meal and 11 lbs of soybean oil (hulls excluded in this example). The cost of crushing a bushel of soybeans is $.22. Soybean oil can be sold at the split-off point for $.24 per lb and soybean meal for $.10 per lb. The total joint cost of $7,220 consists of the cost of the soybeans themselves (1,000 bushels x $7 = $7,000) plus the joint processing cost necessary to split the soybeans into meal and oil (1,000 bushels x $.22 = $220). Physical Measures Method This method is the simplest and easiest to apply. It assumes that each pound (or other physical measure) of one primary product is equal in value to a pound of another primary product. Joint costs are allocated to primary products in proportion to the pounds (or other physical measure) of primary products produced (see Example 1). In this example, 60,000 lbs of soybeans were crushed to produce 49,000 lbs of meal and 11,000 lbs of oil. The joint cost of $7,220 is allocated to meal and oil in proportion to the physical weights of the primary products produced. The 49,000 lbs of soybean meal consists of 49,000/60,000 of all products produced; consequently, $5,896 (49/60 X $7,220) of the total joint cost of $7,220 should be allocated to soybean meal. Although simple and easy to apply, the physical measures method does not consider the values of the primary products, only physical measures. In the soybean example, a pound of soybean oil is more than twice as valuable as a pound of soybean meal. Thus, the physical measures method has very limited applications because there are so few situations where pounds (or other physical measures) also represent value. Value at Split-Off Point Method This method considers market factors by recognizing that primary products produced from a common process have different values. Market factors affect both the selling price of soybeans and the decision to purchase and crush soybeans into meal and oil. To allocate joint costs, this method uses the proportion of the value of each primary product at the split-off point to the total value of all primary products at the split-off point. Consequently, primary products with higher sales values are allocated relatively more joint cost than primary products with lower sales values (see Example 2). In this example, the sales value of the soybean meal produced is $4,900 and the sales value of the soybean oil produced is $2,640. The separate sales values of each primary product in relation to the combined sales values of all primary products reflect the relative value of each. In this case, the relative value (proportion) of soybean oil to total value is $2,640/$7,540. The relative proportions are then used to allocate the joint cost of $7,220 to the primary products. Of the $7,220 of joint cost, soybean meal is allocated $4,692 and soybean oil is allocated $2,528. Examples 1 and 2 show that the two methods--one based on physical proportions and one based on value proportions--produce significantly different results for joint cost allocation The apportionment or designation of an item for a specific purpose or to a particular place. In the law of trusts, the allocation of cash dividends earned by a stock that makes up the principal of a trust for a beneficiary usually means that the dividends will be treated as . A comparison of the examples reveals that that while soybean oil comprises only 18.3 percent of the physical proportions of soybean products (11,000 lbs/60,000 lbs), it comprises 35 percent ($2,6401$7,540) of the value proportions of the soybean products. The value at split-off point method takes into consideration market factors when valuing the various primary products produced from a common process. This method is more costly to apply than the physical measures method. In some cases, one or more of the primary products produced may not be salable sal·a·ble also sale·a·ble adj. Offered or suitable for sale; marketable. sal  a·bil at the split-off point but must be processed further before a
sales value is available. Using the value at split-off point method, we
can substitute the estimated sales value for the actual sales value at
the split-off point. The estimated sales value at the split-off point is
found by computing computing - computer the total sales value of a primary product at the
point closest to the split-off point and then subtracting the
appropriate further processing cost from this total (see Example 3).
Modify the original example data by assuming that soybean oil cannot be sold at the split-off point but must be processed further at a cost of $.03 per lb, after which it can be sold for $.28 per lb. The sales value for soybean oil is not available at the split-off point but can be estimated by taking the total sales value for soybean oil at the point closest to the split-off point, $3,080 ($.28 per lb X 11,000 lbs), and subtracting the further process cost of $330 ($.03 per lb X 11,000 lbs). The resulting $2,750 ($3,080 - $330) represents the estimated sales value at the split-off point and is used as a substitute for the actual sale value at the split-off point. This modified mod·i·fy v. mod·i·fied, mod·i·fy·ing, mod·i·fies v.tr. 1. To change in form or character; alter. 2. approach accommodates situations where sales values are not available at the split-off point. However, it does not properly recognize the value added Value Added The enhancement a company gives its product or service before offering the product to customers. Notes: This can either increase the products price or value. by the further processing cost. As a general rule, adding cost to a product also adds value, in turn increasing its selling price. The greater the further processing cost is for a primary product, the more the final selling price is a result of that further processing cost. The result is that the estimated value at the split-off point, for those products that have significant further processing costs, is overstated o·ver·state tr.v. o·ver·stat·ed, o·ver·stat·ing, o·ver·states To state in exaggerated terms. See Synonyms at exaggerate. o by the gross profit associated with the further process cost. This weakness can be overcome by using the net estimated total sales value at the split-off point. This is computed by subtracting both the further processing cost and the gross profit associated with the further processing cost from the sales value closest to the split-off point. Constant Gross-Profit Percentage Method This method assumes that each of the primary products produced contributes proportionately pro·por·tion·ate adj. Being in due proportion; proportional. tr.v. pro·por·tion·at·ed, pro·por·tion·at·ing, pro·por·tion·ates To make proportionate. to the profits of the company. Under this method, costs are allocated so that each of the primary products realizes the same gross-profit percentage (see Example 4, below). Modify the original example data by assuming that the 49,000 lbs of soybean meal are further processed at a cost of $1,470 ($.03 per lb), then sold for $6,860 ($.14 per lb), and that the 11,000 lbs of soybean oil are further processed at a cost of $880 ($.08 per lb), then sold for $3,960 ($.36 per lb). This method essentially computes the total cost for each primary product by subtracting the gross profit of each primary product from the related total sales value. Since the total cost consists of both further processing cost and allocated joint cost, the allocated joint cost can be computed for each primary product by subtracting the further process cost of each product from the total cost of each. In Example 4, one can see that the total cost of meal ($6,068) is computed by subtracting the gross profit of meal ($792) from the sales value of meal ($6,860). The joint cost allocated to meal ($4,598) is computed by subtracting the further processing cost of meal ($1,470) from the total cost of meal ($6,068). The constant gross-profit method treats each of the primary products as proportionately equal in importance to the company and to the generation of profits. However, it fails to recognize the unique contribution made by the further processing cost for each product. In many cases, the further processing cost improves the product to the point where the increase in selling price is disproportionate dis·pro·por·tion·ate adj. Out of proportion, as in size, shape, or amount. dis pro·por to the
increase in further process cost. The constant gross-profit method
ignores these unique contributions and allocates cost as though all
further processing costs make the same percentage contribution.
BYPRODUCTS Classifying products as byproducts or as primary products is primarily a management decision. It is not uncommon for products to be reclassified from byproducts to primary products and vice versa VICE VERSA. On the contrary; on opposite sides. . Classification usually relates to the significance of the revenue received form the sale of these products. Instead of allocating joint costs to byproducts using one of the methods discussed previously, they are absorbed Absorbed 1. In a general business sense, when a cost is treated as an expense instead of being passed on to the customer in the form of higher prices. 2. In underwriting, when an issue has been completely sold to the public. 3. by the primary products. The net revenue received or to be received from the sale of byproducts, however, may be accounted for in a number of ways. Three commonly used methods of accounting for byproducts are as follows: Cost Reduction/Produced Method. The net proceeds Net Proceeds The amount received after all costs are deducted from the sale of a piece of property or security. Notes: In the case of an investor selling a security, net proceeds represent the proceeds from the sale minus any trading costs (i.e. commissions). received and net proceeds to be received from the sale of the byproducts produced in the current period are accounted for and treated as a reduction of the cost of the related primary products produced in the current period. Cost Reduction/Sold Method. Only the net proceeds received from the byproducts sold in the current period are accounted for and treated as a reduction of the cost of the related primary products produced in the current period. Revenue/Sold Method. Only the net proceeds received from the byproducts sold in the current period are accounted for and shown in the income statement as byproduct revenue. The advantages of the two "cost reduction" methods are that (1) they are theoretically sound because they give the primary product credit for the pieces of it that were sold off or will be sold off, and (2) they de-emphasize de-em·pha·size tr.v. de-em·pha·sized, de-em·pha·siz·ing, de-em·pha·siz·es To decrease the emphasis on; minimize the importance of. de-em byproducts by having no byproduct revenue reflected on the income statement. The advantage of the "revenue" method is that it is simpler. The example above (see Example 5) assumes that the company makes one primary product and one byproduct from a common process with a joint cost of $10,000. The comparative income statement shown below reflects the differences in accounting using the three byproduct methods. The cost reduction/produced method reduces the joint cost ($10,000) by the total value (sales proceeds) of the byproduct produced in the current period. This includes both the proceeds of the byproduct produced and sold this period ($200) and the proceeds of the byproduct produced this period and sold later ($300). The cost reduction/sold method, a simplified sim·pli·fy tr.v. sim·pli·fied, sim·pli·fy·ing, sim·pli·fies To make simple or simpler, as: a. To reduce in complexity or extent. b. To reduce to fundamental parts. c. version, reduces the joint cost only by the value of the byproduct actually sold ($200) this period. The revenue/sold method, the simplest method of the three, records the proceeds from byproduct sold in the current period as a revenue. Occasionally small companies incur To become subject to and liable for; to have liabilities imposed by act or operation of law. Expenses are incurred, for example, when the legal obligation to pay them arises. An individual incurs a liability when a money judgment is rendered against him or her by a court. scrap (residual parts of material left over) as part of the production process. The proceeds received from the sale of scrap are generally minor and can be accounted for by the revenue/sold method. Management of small companies should periodically review both their classification of products as primary products or as byproducts, and the accounting methods that they use for these products.
EXAMPLE 1
ALLOCATION JOINT
PRIMARY PRODUCTS POUNDS BY WEIGHT COST
Soybean Meal (1,000 bu X 49 lbs) = 49,000 lbs 49/60 X $7,220 =
Soybean Oil (1,000 bu X 11 lbs) = 11,000 lbs 11/60 X $7,220 =
Total 60,000 lbs 60/60
ALLOCATED
PRIMARY PRODUCTS JOINT COST
Soybean Meal (1,000 bu X 49 lbs) = $5,896
Soybean Oil (1,000 bu X 11 lbs) = $1,324
Total $7,220
EXAMPLE 2
SELLING VALUE AT ALLOCATION JOINT
PRIMARY PRODUCTS POUNDS PRICE SPLIT-OFF BY VALUE COST
Soybean Meal 49,000 lbs X $10 = $4,900 490/754 X $7,220 =
Soybean Oil 11,000 lbs X $.24 = $2640 2 64/754 X $7,220 =
Total 60,000 lbs $7,540 754/754
ALLOCATED
PRIMARY PRODUCTS JOINT COST
Soybean Meal $4,692
Soybean Oil $2,528
Total $7,220
EXAMPLE 3
FURTHER
PRIMARY SELLING PROCESS VALUE AT
PRODUCTS POUNDS PRICE VALUE COST SPLIT-OFF
Meal 49,000 lbs X $.10 = $4,900 - 0 = $4,900
Oil 11,000 X $.28 = $3,080 - $330 = $2,750
$7,650
ALLOCATED
PRIMARY ALLOCATION JOINT
PRODUCTS BY VALUE COST JOINT COST
Meal 490/765 X $7,220 = $4,625
Oil 275/765 X $7,220 = $2,595
$7,220
EXAMPLE 4
MEAL OIL TOTAL
Step 1. Compute the combined
gross-profit percentage:
Sales $6,860 $3,960 $10,820
Further process cost 1,470 880 2,350
Joint cost (original
example) ? ? 7,220
Total cost 9,570
Gross profit $1,250
Gross-profit percentage
($1,250/$10,820) 11.55%
Step 2. Distribute gross-profit
proportionately and compute
allocated joint cost:
Sales $6,860 $3,960 $10,820
Less gross profit 792 (1) 458 (2) 1,250
Equals total cost 6,068 3,502 9,570
Less further
process cost 1,470 880 2,350
Equals allocated
joint cost $4,598 $2,622 $7,220
(1) (792=$6,860 X 11.55%)
(2) (458=$3,960 X 11.55%)
EXAMPLE 5
BEGINNING UNITS UNITS ENDING SELLING
INVENTORY PRODUCED SOLD INVENTORY PRICE
PRODUCT (LBS) (LBS) (LBS) (LBS) (PER LB)
Primary Product 0 10,000 8,000 2,000 $3.00
Byproduct 0 1,000 400 600 $0.50
EXAMPLE 6
INCOME STATEMENT: BYPRODUCTS
METHOD
COST REDUCTION/ COST REDUCTION/
PRODUCED SOLD
Sales:
Primary Product $24,000 $24,000
Byproduct
Total Sales $24,000 $24,000
Cost of Goods Sold (COGS):
Manufacturing Cost $10,000 $10,000
Less Byproduct Sold (200) (200)
Less Byproduct Unsold (1) (300)
Net Mfg. Cost--Primary 9,500 9,800
Less Ending Inv.--Primary (2) (1,900) (1,960)
Total COGS: 7,600 7,840
Gross Profit $16,400 $16,160
METHOD
REVENUE/
SOLD
Sales:
Primary Product $24,000
Byproduct 200
Total Sales $24,200
Cost of Goods Sold (COGS):
Manufacturing Cost $10,000
Less Byproduct Sold
Less Byproduct Unsold (1)
Net Mfg. Cost--Primary 10,000
Less Ending Inv.--Primary (2) (2,000)
Total COGS: 8,000
Gross Profit $16,200
(1) Unsold byproducts are inventoried at their selling price (or net
realizable value) with the credit going to manufacturing cost. The entry
would be:
Byproduct Inventor 300
Manufacturing Cost 300
In the following period when the byproduct is sold the entry would be:
Cash 300
Byproduct Inventory 300
(2) The ending inventory values for the primary products were computed
by dividing the net manufacturing cost for each method by the 10,000
units produced and multiplying the resulting per unit cost ($.95, $.98
and $1.00, respectively) by the 2,000 units of primary product remaining
in ending inventory.
RELATED ARTICLE: Practice Tip: Speed up your collections by Faxing your invoice An itemized statement or written account of goods sent to a purchaser or consignee by a vendor that indicates the quantity and price of each piece of merchandise shipped. A consular invoice is one used in foreign trade. to the client. Fax documents convey convey v. to transfer title (official ownership) to real property (or an interest in real property) from one (grantor) to another (grantee) by a written deed (or an equivalent document such as a judgment of distribution which conveys real property from an estate). a sense of urgency that will sometimes "wake up" that slow-paying debtor One who owes a debt or the performance of an obligation to another, who is called the creditor; one who may be compelled to pay a claim or demand; anyone liable on a claim, whether due or to become due. . P. Douglas Marshall Sir Douglas Marshall (2 October 1906 – 24 August 1976) was a British Conservative Party politician, and Member of Parliament for Bodmin from 1945 to 1964. At the 1964 general election, he lost his seat to the Liberal Party candidate Peter Bessell. , CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. , PhD, is a professor in the Department of Accounting and Legal Studies in the Perdue Perdue may refer to:
1 City (1990 pop. 12,711), seat of Saline co., N central Mo.; inc. 1839. In a large farm area, it is a processing center for grain, eggs, meat, and dairy products. Marshall is the seat of Missouri Valley College. , who received his PhD from the University of Maryland, College Park The University of Maryland, College Park (also known as UM, UMD, or UMCP) is a public university located in the city of College Park, in Prince George's County, Maryland, just outside Washington, D.C., in the United States. , was a senior accountant A person who has the requisite skill and experience in establishing and maintaining accurate financial records for an individual or a business. The duties of an accountant may include designing and controlling systems of records, auditing books, and preparing financial statements. with Price Waterhouse There have been several famous people with the surname Waterhouse:
American army engineer and parliamentary authority. He designed the defenses for Washington, D.C., during the Civil War and later wrote Robert's Rules of Order (1876). Noun 1. F. Dombrowski, CPA, DBA, is a professor and Chairman of the Department of Accounting and Legal Studies in Perdue School of Business at Salisbury University. Dr. Dombrowski, who received his DBA from Louisiana Tech University Louisiana Tech University, at Ruston; coeducational; state supported; chartered 1894, opened 1895 as an industrial institute. It became Louisiana Polytechnic Institute in 1921 and attained university status in 1970. , was a Colonel COLONEL. An officer in the army, next below a brigadier general, bears this title. in the United States Air Force United States Air Force (USAF) Major component of the U.S. military organization, with primary responsibility for air warfare, air defense, and military space research. It also provides air services in coordination with the other military branches. U.S. before joining the University. Both authors have published extensively in other accounting and business journals. |
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