Joint costs are allocated among the joint products using various cost allocation methods. The choice of allocation method depends on factors such as the nature of the products, industry practices, and management’s objectives. Here are some common methods for allocating joint costs:
- Relative Sales Value Method: The relative sales value method allocates joint costs based on the proportionate sales values of the individual products. It considers the market prices or sales values of each product and allocates joint costs accordingly. This method assumes that the sales value reflects the relative benefit derived from the joint process.
- Physical Quantity Method: The physical quantity method allocates joint costs based on the physical quantities of the products. It assigns costs based on the volume, weight, or other measurable units of the products. This method assumes that the physical quantity is a reasonable measure of the benefits obtained from the joint process.
- Net Realizable Value Method: The net realizable value method allocates joint costs based on the estimated net realizable values of the products. Net realizable value is the expected selling price minus any additional costs necessary to make the product ready for sale. This method considers the profitability and marketability of each product in determining the cost allocation.
- Constant Gross Margin Percentage NRV Method: The constant gross margin percentage net realizable value (NRV) method allocates joint costs by maintaining a consistent gross margin percentage across the joint products. It calculates the expected gross margin for each product based on its estimated NRV and then allocates the joint costs proportionately to achieve the desired gross margin percentage.
- Standard Cost Method: The standard cost method allocates joint costs based on predetermined standard costs for each product. Standard costs are established based on historical data or industry benchmarks. This method assumes that the standard costs represent the relative benefits derived from the joint process.
- Contribution Margin Method: The contribution margin method allocates joint costs based on the contribution margin ratio of each product. The contribution margin is the difference between sales revenue and variable costs. This method allocates joint costs in proportion to the contribution margin ratio, assuming that the contribution margin reflects the relative benefits obtained from the joint process.
It’s important to note that there is no universally applicable method for allocating joint costs, and different situations may call for different approaches. Management needs to carefully evaluate the characteristics of the joint products and select an allocation method that best aligns with the objectives of cost allocation, pricing decisions, and performance evaluation within their specific industry and organizational context.