Relative sales value method of allocating cost

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Under market or sales value method, the joint cost incurred in a joint production process is allocated to different joint products on the basis of their market or sales value.

The method refers to a systematic allocation of joint cost attached to a specific joint production process based upon the real market or sales value of the products that come into existence as a result of running that joint production process. The method makes use of a weighted average of market values of all the joint products and the cost is apportioned amongst the products based on their respective shares of sales values.

The market value method is an industry preferred method for allocating joint cost among joint products because the market or sales value of any product is considered one of the most reliable indicator of its economic value and the costs attached to it.

Example 1

The Steven Company produces four products – product A, product B, product C and product D. These four products are produced from a single raw material using a joint production process. All the products have a market value at split-off point and can be sold to customers without any further processing. The total joint cost incurred in the most recent production run is $486,000. The quantities produced of four products and their market or sales values per unit at split-off point are given below:

Required: Allocate joint cost among four joint products using market value method.

Solution

*Total joint cost is 60% of the total market value of all joint products
($486,000/$810,000) × 100 = 60%

The allocation of joint cost on the basis of market value at split-off point has been made as follows:

• Product A: $20,000 × 0.6 = $12,000
• Product B: $180,000 × 0.6 = $108,000
• Product C: $210,000 × 0.6 = $126,000
• Product D: $400,000 × 0.6 = $240,000

Cost after split-off point

Some products may require further processing after split-off point before they can be sold in the market. Such products may not have a market value at the split-off point. In such situations, the joint cost is allocated on the basis of a hypothetical market value at split-off point which is equal to the ultimate sales or market value of the product less processing cost incurred on individual products after split-off point.

The formula for calculating hypothetical market value of a product at its split-off point can be written as follow:

Hypothetical market value at split-off point = Ultimate market value – Processing cost after split-off point

The use of hypothetical market value for proration of joint cost among joint products is illustrated in example 2 below:

Example 2

The Robert Company produces three products – product X, product Y and product Z. These products are produced from a single raw material in a joint production process. The products do not have a market value at split-off point and require a further processing to place them in the saleable condition. The joint production cost for a recently completed production run is $16,500. Other relevant data is given below:

Required: Allocate joint production cost to joint products assuming the Robert company uses a market value method of joint cost allocation.

Solution

*Total joint cost is 55% of the total hypothetical market value of all joint products:
($16,500/$30,000) × 100 = 55%

The allocation of total joint cost on the basis of hypothetical market value at split-off point has been made as follows:

• Product X: $8,000 × 0.55 = $4,400
• Product Y: $10,000 × 0.55 = $5,500
• Product Z: $12,000 × 0.55 = $6,600

**Total production cost:

• Product X: $4,400 + $1,000 = $5,400
• Product Y: $5,500 + $2,000 = $7,500
• Product Z: $6,600 + $4,000 = $10,600

Sometimes figuring the cost of your products is simple. You spend ​$500​ to make 200 identical ​$5​ items for sale. As they're all the same, you allocate ​$2.50​ in costs to each item when it's time to do the accounting. If you have 50 ​$5​ items, 67 ​$10​ items and 83 ​$3​ items, the allocation is more complicated. The market value method of joint cost allocation is one way to figure it out.

Say you have ​$200​ in manufacturing costs to create three items worth ​$200, $250​ and ​$350.​ As the ​$200​ item accounts for 25 percent of the total sale price, you'd allocate it 25 percent of the costs, or ​$50​.

Manufacturing and processing frequently produce multiple products, The Strategic CFO points out. A poultry plant, for example, may turn chickens into breasts, drumsticks and byproducts that go into dog food. To figure out profit margins on the different products, you need a method for apportionment of joint costs: How much labor, chicken prices and overhead do you credit to the breasts?

Accounting Tools explains that this method is more an accounting exercise than a practical one. If your ironworks turns raw ore into two dozen different cast-iron products, it's unlikely you can figure exactly how much labor and overhead went into each. This uncertainty is an advantage: You don't have to worry about getting it perfect, just finding a formula that's meets accounting standards.

The Smeal College of Business describes several acceptable methods for apportionment of joint costs. One is by physical measure. If you have 10 pounds of drumsticks and 100 pounds of chicken breasts, you allocate 10 times as much cost to the breasts. Another is the relative sales value or market value method of joint cost allocation, where you divide up joint costs based on the price of the products.

The first step in the relative sales value method is identifying the split-off point at which the various products accumulate separate costs. For example, you run a chemical plant where the same process turns a mixture into multiple different chemical products. In the early stages, when you mix chemicals and process them, you generate joint costs. Once you can identify the products separately, you've reached the split-off point. Subsequent spending no longer creates joint costs.

Suppose the end result of your manufacturing creates 10 ​$50​ items – ​$500​ total – and 20 ​$30​ items totaling ​$600​. The production costs prior to the split-off point are ​$600​. The ​$500​ of items is 45 percent of the total sale price, so you assign 45 percent of the costs, or ​$270,​ to them. The ​$600​ set of items is 55 percent of the sale price, so you apportion 55 percent of the cost, or ​$330,​ to them.

You can also use this method if you're buying and developing real estate, Accounting Coach advises. If you buy ​$10 million​ of residential land and sell the lots for different prices, you can use the market value method of joint cost allocation to determine how much of the purchase price should be credited to each lot.

If you're debating what price to set for your products, the relative sales value method is not a tool to use for that. Allocating joint costs doesn't suggest what the price should be. Costs after the split-up point are more important because they're tied to each specific product.