The physical units method, also known as the physical quantity method, is a cost allocation method used to allocate joint costs among the joint products based on the physical quantities produced. It assigns costs based on the volume, weight, or other measurable units of the products. The underlying assumption is that the physical quantity is a reasonable measure of the benefits obtained from the joint process.
Here’s how the physical units method of allocating joint costs works:
- Determine the Total Joint Costs: Calculate the total joint costs incurred up to the split-off point in the joint manufacturing process. These costs include expenses such as direct materials, direct labor, and factory overhead that are collectively incurred for all the joint products.
- Identify the Physical Quantities: Determine the physical quantities of each joint product produced during the production process. Physical quantities can be measured in units such as weight, volume, length, or any other relevant measure.
- Calculate the Allocation Ratio: Calculate the allocation ratio for each joint product by dividing its physical quantity by the total physical quantities of all the joint products. The allocation ratio represents the proportionate share of the joint costs that each product should bear based on its physical quantity.
- Allocate Joint Costs: Multiply the total joint costs by the allocation ratio for each joint product to determine the allocated joint costs for each product. The allocated costs represent the portion of the total joint costs assigned to each product based on its physical quantity.
- Cost Assignment: Allocate the allocated joint costs to the respective joint products for proper cost assignment. These allocated costs will be used for inventory valuation, cost determination, pricing decisions, and performance evaluation of the individual products.
It’s important to note that while the physical units method is a straightforward approach, it assumes that the physical quantities of the joint products are a reasonable indicator of the benefits received from the joint process. However, in certain cases, using other cost allocation methods such as the relative sales value method or net realizable value method may be more appropriate, especially when physical quantities do not accurately reflect the economic value of the products.
The choice of the cost allocation method depends on the specific circumstances, nature of the products, and management’s objectives.
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