What is the Joint Cost? How does it work?

Joint cost

Joint cost is the cost that adds value to more than one process of the business. It’s incurred while expecting economic benefits/value addition in more than one product/process.

The consumption of the resources starts to generate economic benefits for the two products after attaining the split-off point.

Split-off point

It’s the point at production stage where joint resource gets separation from each other to be used in their respective product line.

Most businesses incur joint costs in areas of raw material purchases, manufacturing processes, supplies consumptions, and other costs that impact two or more cost objects of the business production.

Uses of the joint cost

 The mains uses of the joint cost are listed below,

  1. The allocation of the joint cost ensures accuracy in the valuation of inventory.
  2. It helps to set appropriate selling prices considering the resources consumed by different units of production.
  3. It helps to ascertain the product’s profitability.
  4. It helps the business owner to make decisions regarding maintaining resources as per the demand of the specific product. In other words, it’s helpful in the process of inventory management and purchase planning.

Methods of joint cost apportionment

The methods for the joint cost apportionment include followings,

1- Physical units method

The physical unit method allocates the joint cost to the units of production. It makes use of the physical quantity of the specific units produces as a result of the process that consumed the resources purchased with the joint cost.

For instance, the business purchases 1,000 kg of whole wheat and costs USD 20 per kg. It’s processed in the facility and produces 700 kg of white flour and, 300 kg of brown flour. Since the whole wheat is a joint cost that produced two outputs after the split-off.

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Product            Production in KG% of total productionCost apportionment
White flour70070%14,000 (20,000*0.7)
Brown sugar30030%6,000 (20,000*0.3)

Using physical units methods, the business can allocate the total cost of USD 20,000 (1,000*20) in the total manufactured physical quantity of 1,000 kg of white sugar and brown sugar.

So, the cost of material for white sugar will be USD 14,000 (20,000/1,000*700) and, the cost of material for the brown sugar to be allocated will be USD 6,000 (20,000/1,000*300).

2- Average unit cost method

The average unit cost method allocates the joint cost based on the average production of the units.

For instance, the oil industry used 10,000 liters of crude oil as joint cost. The crude oil costs USD 2 per liter. The filtration facility of the business produced 5,000 liters of Petrol, 3,000 liters of gasoline, and 2,000 liters of high octane. The joint cost can be allocated as follows.

ProductsLiters productionAverage unit cost *Cost apportionment
Higher octane2,00024,000

Average unit cost *

3- Sales value method

The sales value method uses selling price as a basis for the apportionment of the joint cost. The sales price to be used may be based on unit prices and the sales price may be based on sales value.

The use of the sales value seems to be the fair and more relevant basis for the apportionment. Let’s understand the concept based on the sales value method of apportionment.

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For instance, the company manufactures product-A, product-B, and product-C using joint costs. The joint cost incurred by the business was USD 70,000 for the period under consideration.

The sales value of product-A was USD 20,000, product B 35,000, product 45,000. The joint cost can be apportioned based as follows.

ProductSales valueRatio of sales valueApportionment
Product-A20,0000.214,000 (70,000*0.2)
Product-B35,0000.321,000 (70,000*0.3)
Product-C45,0000.5035,000 (70,000*0.5)

4- Survey method

In the survey-based method of cost apportionment, the survey is carried for the qualitative features of units produced. Based on survey results the points are allocated to the units produced.

The logic behind the idea is that the product good in quality should be apportioned more proportion of the joint cost. Let’s understand the concept with examples as follows.

Consider a farming land where three types of crops are grown. These crops include wheat, corn, and rice. The surveyor allotted the points of 3, 2.5, and 4.5 as per technical specifications, and tons produced were 2,000, 5,000, and 3,000 respectively. The joint cost of the farmer was USD 100,000.

ProductsUnits producedAllotted pointsPoints weighted units (quantity * points)Weighted units ratioCost per unit (*)Cost apportionment (Ratio*average cost)
Total10,000 32,000100 100,000

*Cost per unit

Other methods of cost allocation include the reverse cost method, contribution margin method, and the standard cost method, etc.

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These methods of allocation make use of net profit margin or net realizable value, contribution margin, and the standard cost as a basis of allocation.

Examples of joint cost

Consider a factory that manufactures different types of beverages and different refreshing drinks. The business needs pure water to be included in the process.

The business purchases the water from a water purification company and uses it in the production of multiple beverages.

Since the water is the same and it is consumed in different beverages. Hence, the cost incurred on the water is a joint cost and needs to be allocated to the different beverages manufactured by the business. Given are some of the industry specific examples of the joint costs.

Joint cost and oil industry

The oil industry is well known for using joint cost accounting. The oil filtration business processes the crude oil to produce petrol, gasoline, and higher octane, etc from a single resource consumed.

Hence, the cost incurred on the purchase of crude oil is a joint cost that needs to be allocated.