How do you account for joint costs and by-products in cost-volume-profit analysis?

1 Joint products and by-products

Joint products are two or more products that are produced simultaneously from a common input or process, such as oil and gas from a well, or cheese and whey from milk. By-products are products that have a relatively low sales value compared to the main products, such as sawdust from lumber, or molasses from sugar. Joint costs are the costs incurred up to the point where the joint products or by-products can be identified and separated, such as the cost of raw materials, labor, and overhead. The challenge is how to allocate these joint costs to the individual products for inventory valuation and income measurement.

2 Allocation methods

There are several methods for allocating joint costs to joint products, but the most common ones are based on the relative sales value, the physical units, or the net realizable value of the products. The sales value method allocates the joint costs in proportion to the sales value of each product at the split-off point, where they can be sold or processed further. The physical units method allocates the joint costs in proportion to the physical measure of each product, such as weight, volume, or units. The net realizable value method allocates the joint costs in proportion to the estimated sales value of each product after deducting any further processing costs. Each method has its advantages and disadvantages, and the choice depends on the nature of the products and the industry.

4 CVP analysis

CVP analysis helps you determine the sales volume and product mix that will generate a target profit or breakeven. To perform CVP analysis, you need to know the fixed costs, the variable costs, and the contribution margin of each product. The contribution margin is the difference between the sales price and the variable cost of a product, and it represents the amount that contributes to covering the fixed costs and generating profit. When you have joint products or by-products, you need to adjust the contribution margin of each product based on the joint cost allocation and by-product accounting methods you use. For example, if you use the sales value method for joint cost allocation and the sales method for by-product accounting, you need to subtract the allocated joint costs from the sales price and add the sales value of the by-products to the variable cost of each product to calculate the contribution margin.