How do you use joint cost allocation to support pricing and marketing decisions?

1 Why is it important?

Joint cost allocation is important for several reasons. First, it helps you measure the profitability and performance of each product or service that you offer. By allocating joint costs, you can compare the revenues and costs of different products or services and identify the most and least profitable ones. Second, it helps you make informed pricing and marketing decisions. By knowing the cost of each product or service, you can set prices that cover your costs and generate a desired profit margin. You can also allocate your marketing budget and resources to promote the products or services that have the highest demand and profitability.

2 What are the methods?

There are several methods of joint cost allocation, each with its own advantages and disadvantages. One method is the physical measure method, which allocates joint costs based on a physical measure of output, such as weight, volume, or units. This is a simple and objective approach, but it may not reflect the relative value or marketability of each product or service. Another method is the sales value method, which allocates joint costs based on the sales value of each product or service at the split-off point. This is more realistic and relevant, but it may not be applicable if the products or services are not sold at the split-off point or have different selling prices in different markets. The net realizable value method allocates joint costs based on the net realizable value of each product or service, which is the sales value minus any separable costs incurred after the split-off point. This method is consistent with the matching principle and income statement presentation, but it may require more information and estimation than the other methods.

3 What are the challenges?

Joint cost allocation presents certain challenges, such as choosing the appropriate method for your products or services, avoiding irrelevant costs, and updating cost information. When selecting a method, you need to consider the nature of your products or services, the availability and reliability of data, the purpose and use of cost information, and the impact on behavior and incentives. It is important to remember that joint costs are sunk costs and should not influence pricing or marketing strategies. To ensure accuracy and relevance of cost information, it is necessary to regularly update it to reflect changes in input prices, output quantities, sales prices, separable costs, and market conditions.

4 How do you apply it?

In order to apply joint cost allocation, you must first identify the joint products or services that share the same inputs or processes. Next, you need to determine the total joint costs incurred before the split-off point. Then, select an allocation method and basis that is suitable to your purpose and situation. Subsequently, allocate the joint costs to each product or service based on the selected method and basis. Finally, analyze the cost information and utilize it to back up your pricing and marketing decisions.

5 What are some examples?

Joint cost allocation can be used to support pricing and marketing decisions in a variety of ways. For instance, a petroleum refinery may use the net realizable value method to allocate joint costs based on the market prices and separable costs of each product. This information can then be used to set prices that cover costs and achieve a target return on investment, as well as allocate advertising and promotion expenses to the products with the highest profit potential and customer demand. Similarly, a furniture manufacturer may use the physical measure method to allocate joint costs based on the volume of wood used for each product. This information can be used to compare the profitability and performance of each product line, as well as determine whether to discontinue or expand any product line based on the contribution margin and market demand. Finally, a pharmaceutical company may use the sales value method to allocate joint costs based on the selling prices of each product at the split-off point. This information can be used to determine the break-even point and margin of safety for each product, as well as design its pricing and marketing mix based on the elasticity and competition of each product.

6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?