Market Value Method or Reversal Cost Method

Market Value Method or Reversal Cost Method:

Learning Objectives:

  1. Define and explain market value method.
  2. Explain the use of market value method while costing by-products

Market value method or Reversal cost method is similar to the last technique (By Product Revenue deducted from Production Cost) illustrated at recognition of gross revenue method page. However it reduces the manufacturing cost of the main product , not by the actual revenue received, but by an estimate of the by products value at the time of recovery. This estimate must be made prior to split-off from the main product. Dollar recognition depends on the stability of the market as to price and stability of by product; however, control over quantities is important. The by product account is charged with this estimated amount and the production (manufacturing) cost of the main product is credited. Any additional costs of materials, labor, or factory overhead incurred after the by-product is separated from the main product are charged to the by product. The marketing and administrative expenses might also be allocated to the by product on some equitable basis. The proceeds from sales of the by product are credited to the by-product account.  The balance in this account can be presented on the income statement in one of the ways outlined for recognition of gross revenue method except that the manufacturing cost applicable to by product inventory should be reported in the balance sheet.

The market value method (reversal cost method) of ascertaining main product and by-product costs may be  illustrated as shown in the example below:

Item Main Product By Product
Materials $50,000
Labor 70,000
Factory Overhead 40,000
——–
Total production cost (40,000 units) $160,000
Market value (5,000 units @ $1.80) $9,000
Estimated gross profit consisting of:
(20% of selling price, assumed) $1,8000
Marketing and selling expenses 5% of selling price 450
—— $2,250
——-
Estimated production cost after split-off:
Materials $1,000
Labor 1,200
Factory Overhead 300
——- 2,500
——-
Estimated value of by product at split-off to be credited to main product
4,250

$4,250
———
Net cost of main product $155,750
Add back actual production cost after split-off 2,300
———
Total $6,550
======
Total number of units 40,000 5,000
Unit cost $3.894 $1.31

This example indicates that an estimated value of the by product at the split-off point results when estimated gross profit and production cost after split-off are subtracted from the by-products ultimate market value. Alternatively, if the by-product has a market value at the split-off point, the by-product account is charged with this market value and the main product’s production cost would be credited. It is also possible to use the total market values of the main product and the by-product at the split-off point as a basis for assigning a share of the prior split-off costs to the by product, applying the offsetting credit to the production cost of the main product. In any event, subsequent to split-off cost related to the by-product would be charged to the by product.

Market value method or reversal cost method is based on the theory that the cost of a by product is related to its sales value. It is a step toward the recognition of a by-product cost prior to its split-off from the main product. It is also the nearest approach to methods employed in joint product costing.

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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