Joint Product Cost Analysis for Managerial Decisions and Profitability Analysis

Joint Product Cost Analysis for Managerial Decisions and Profitability Analysis:

Learning Objectives:

  1. What is the importance of joint product cost analysis for management.

The Securities and Exchange Commission requires that annual reports to stock holders include data by lines of business. Likewise, the Federal Trade Commission requires that certain business furnish  cost and profit data for a wide range of specific product categories. The financial Accounting Standards Board requires business enterprise, excluding nonpublic enterprises, to report in their annual external financial statements the revenue, operating each significant industry segment of their operations. “Significant” generally means 10 percent or more of the total of respective amounts. Aggregate depreciation, depletion, amortization expense, and the amount of capital expenditures must also be reported for each segment. Furthermore, the FASB requires information about foreign operations, export sales, and major customers, who need not be identified. Also, methods used for cost allocations to segments must be disclosed. Interim financial statements are exempt from these requirements. The SEC’s discloser requirements are consistent with the provisions contained in FASB statements, yet they call for more information than the FASB.

Companies generally resist such requirements. One of their main arguments is that cost allocation today is fraught with great danger of improper interpretation caused by an arbitrary allocated joint cost. Of course, there are acceptable ways of allocating joint product cost. Thus the choice of method makes a difference. The decision determines the degree of profitability of the various individual products.

joint cost allocation methods indicate only too forcefully that the amount of the cost to be apportioned to the numerous products emerging at the point of split-off is difficult to establish for any purpose. Furthermore, the acceptance of an allocation method for the assignment of the joint production cost does not solve the problem. The thought has been advanced that no attempt should be made to determine the cost of individual products up to the split-off point: rather, it seems important to calculate the profit margin in terms of total combined units. Of course, costs incurred after the split-off point will provide management with information needed for decisions relating to the desirability of further processing to maximize profits.

Production of joint products is greatly influenced by both the technological characteristics of the processes and by the markets available for the products. This establishment of a product mix which is in harmony with customer demands appears profitable  but is often physically impossible. It is interesting to note that cost accounting in the meat packing industry serves primarily as a guide to buying, for aggregate sales realization values of the various products that will be obtained from cutting operations are considered in determining the price that a packer is willing to pay for livestock. Sales realization values are also considered when deciding to sell hams or other cuts in a particular stage or to process them further.

A joint cost is often incurred for products that are either interchangeable or not associated with each other at all. Increasing the out put of one will in most joint cost situations unfavorably increase to some extent the out put of the other. These situations fall into the category of the cost-volume-profit relationship and differential cost analysis. Evaluation of many alternative combinations of output can lead to time consuming computations. Often such evaluations are carried out on a computer using sophisticated simulation techniques. Development in operations research procedures have provided techniques helpful in solving such problems (linear programming technique). For profit planning, and perhaps as the only reliable measure of profitability, management should consider a product’s contribution margin after separable or individual costs are deducted from sales. This contribution margin allows management to predict the amount that a segment or product line will add to or subtract from company profit. This margin is not the product’s net profit figure. It indicates relative profitability in comparison with other products. “Net profit determined by allocating to segments an equitable share of all costs, both separable and joint, associated with the group of segments not a reliable guide to profit planning decisions because these data cannot be used for predicting the outcome of decisions in terms of the change in aggregate net profit.” For those reasons, attempts to allocate joint marketing cost to products and customers by time studies of salespersons’ activities, as well as attempts to allocate the joint cost, often yield results which are unreliable for appraising segment profitability.

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