Replacement Cost Method – By Product Costing

Learning Objectives:

  1. Define and explain replacement cost method.
  2. What is the use of replacement cost method while cost by-products?

Replacement cost method ordinarily is applied by firms whose by-products are used within the plant, thereby avoiding the necessity of purchasing materials and supplies from outside suppliers. The production cost of the main product is credited for such materials, and the offsetting debit is to the department that uses the by product. The cost assigned to the by product is the purchase or replacement cost existing in the market. This method is common in the steel industry. Although many by-products are sold in the open market, other products, such as blast furnace gas and coke oven gas, are mixed and used for heating in open hearth furnaces. The waste heat from open hearths is used again in the generation of steam needed by the various producing departments. The resourceful use of these by-products and their accounting treatment are indicated by the following procedure used by a steel company:

  1. Coke oven by-products are credited to the cost of coke at the average sales price per unit for the month.
  2. Coke oven and blast furnace gas are credited respectively to the cost of coke and the cost of big iron at a computed value based on the cost of fuel oil yielding equivalent heat units.
  3. Tar and pitch used as fuel are credited respectively to the cost of coke at a computed value based on the cost of fuel oil yielding equivalent heat units.
  4. Scrape steel remelted is credited to the cost of finished steel at market cost of equivalent grades purchased.
  5. Waste heat from furnaces used to generate steam is credited to the steel ingot cost at a computed value based on the cost of coal yielding equivalent heat units.

You may also be interested in other articles from “by products and joint products” chapter

  1. Difficulties in costing by products and joint products
  2. Joint Products and Joint Product Costs
  3. Characteristics of Joint Products and Cost
  4. By Products
  5. Recognition of Gross Revenue
  6. Recognition of Net Revenue
  7. Replacement cost method
  8. Market value method or reversal cost method
  9. The market or sales value method, based on the relative market values of the individual products.
  10. The quantitative or physical unit method, based on some physical measurement unit such as weight, linear measure, or volume.
  11. The average unit cost method.
  12. The weighted average method, based on a predetermined standard or index of production.

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