Short comings of joint costs standard

Joint Cost

As per my understanding joint costs solely doesn`t depend on Quantity of output, selling price, selling expenses, further processing costs. But two methods which are dependent on these issues are considered widely. And as per my understanding there is no specific relation between selling prices and costs to produce. Costs depend how it has been spent where as selling prices depend on Industry Conditions, Company preferences, Consumer preferences, Demand and Supply etc. In India and in general such apportionment of joint costs are done based on COST ACCOUNTING STANDARD ON JOINT COSTS (CAS-19) issued by the Council of The Institute of Cost Accountants of India explains as follows

1. Introduction

The standard deals with the principles and methods of measurement and assignment of Joint Costs and the presentation and disclosure in cost statement.

2. Objective

The objective of this standard is to bring uniformity, consistency in the principles, methods of determining and assigning Joint Costs with reasonable accuracy.

2. Scope

The standard shall be applied to cost statements, which require classification, measurement, assignment, presentation and disclosure of Joint Costs including those requiring attestation.

4. Definitions

The following terms are being used in this standard within the meaning specified.

4.1. By-Product: output of some value produced incidentally while manufacturing the main product

4.2. Cost Object: This includes a product, service, cost center, activity, sub activity, project, customer or distribution channel or any other units in relation to which costs are ascertained.

4.3 Imputed Cost: Hypothetical or notional costs, not involving any cash outlay computed for any purpose.

4.4 Joint Costs: Joint costs are the cost of common resources used to produce two or more products or services simultaneously.

4.5 Joint product: two or more products produced by the same process and separated in processing, each having a sufficiently high saleable value to merit recognition as a main product.

4.6 Scrap: Discarded material having some value in few cases and which is usually either disposed of without further treatment (other than reclamation and handling) or reintroduced into the production process in place of raw material.

4.7 Split off point: The point in the production process at which joint products become separately identifiable. The terms split off point and separation point are used interchangeably.

4.8 Waste: Material loss during production or storage due to various factors such as evaporation, chemical reaction, contamination, unrecoverable residue, shrinkage, etc. and discarded material which may or may not have a value6.

5. Principles of Measurement

5.1 The principles and methods for measuring Joint costs upto the split off point will be the same as stipulated in other cost accounting standards.

5.2 Cost incurred after split-off point on product separately identifiable shall be measured for the resources consumed for each Joint/By-Product.

5.3 Cost incurred after split- off point for further processing of joint product/By-Product shall be the aggregate of direct and indirect costs.

5.4 Cost of further processing of joint product/By-Product carried out by outside parties shall be determined at invoice or agreed price including duties and taxes, net of discounts (other than cash discount) taxes and duties refundable or to be credited and other expenditure directly attributable to such processing. This cost shall also include the cost of resources provided to outside parties.

5.5 In case the production process generates scrap or waste, realized or realizable value, net of disposal cost, of scrap and waste shall be deducted from the cost of Joint Product.

5.6 Any Subsidy / Grant / Incentive or any such payment received / receivable with respect to any joint product /By-Product shall be reduced for ascertainment of the cost to which such amounts are related.

5.7 Penalties, damages paid to statutory authorities or other third parties shall not form part of the cost of the joint product /By-Product.

6. Assignment

6.1 Joint cost incurred shall be assigned to joint products based on benefits received, which is measured using any of the following methods:

a) Physical Units Method.

b) Net Realizable Value at split-off point.

Net realizable value for this purpose means the net selling price per unit multiplied by quantity (Quantity sold). Net realizable value is to be adjusted for the post- split off costs.

c) Technical estimates

6.2 The value of By-Product shall be estimated using any of the following methods for adjusting joint costs:

a. Net realizable value Net realizable value for this purpose means the net selling price per unit multiplied by quantity (Quantity sold). Net realizable value is to be adjusted for the post- split off costs.

b. Technical Estimates this method may be adopted where the By-Product is not saleable in the condition in which it emerges or comparative prices of similar products are not available.

7. Presentation

The Cost Statement shall present the element wise cost of individual products produced jointly and the value assigned to By-Products.

8. Disclosures

8.1 The Cost statement shall disclose the basis of allocation of Joint costs to individual products and the value assigned to the By-Products

8.2 The Cost statement shall also disclose:

8.3 The disclosure should be made only where material, significant & quantifiable.

8.4 Disclosures shall be made in the body of Cost Statements or as a footnote or as a separate schedule.

8.5 Any change in the cost accounting principles and methods applied for the measurement and assignment of the Joint costs and the value assigned to by-product during the period covered by the cost statement, which has a material effect on the Joint/ By-Products, shall be disclosed. Where the effect of such change is not ascertainable wholly or partly the fact shall be indicated.

By going through this one must consider the backlogs the methods Physical Units method and Net Realisable Value at split-off point (May be called as Adjusted NRV method) for apportionment of joint costs. On face one can understand that Physical Units method can be used only when all the products have equal contribution from joint costs. And in case of Adjusted NRV method too there a thing to be considered which I want to explain by the example.

Consider the following example

Products A and B, Joint cost till split of point – Rs.1,00,000/- . Further processing costs are Rs.10,000/- each. Selling expenses are Rs.10,000/- for A and Rs.20,000/- for B. And this information is for the output of 5,000 units and 5,000 units of A and B respectively. Due to demand constraints, output Selling price depreciated by Rs.2/- per unit of A and Rs.5/- per unit of B in the next period and no change in value of inputs due certain constraints (Say Demand). In this example assume that there are no issues suggesting Technical Estimates

Solution:

Situation : Present Period

Apportionment of Joint costs Under NRV method

Adjusted NRV Ratio A : B   =    14 : 12

Joint Cost apportioned for  A  =   (14 X Rs.1,00,000)/26
                                              =    Rs.53,846.1538/-

Joint Cost apportioned for A = (12 X Rs.1,00,000)/26
                                             = Rs.46,153.8462/-

Apportionment of Joint costs Under Physical Units method

Units Ratio   A : B   = 5 : 5
Joint Cost apportioned for A = Rs.50,000/-
Joint Cost apportioned for B   =  Rs.50,000/-

Situation : Next Period

Apportionment of Joint costs Under NRV method

Adjusted NRV Ratio  A : B   =  130 : 95

Joint Cost apportioned for  A =  (130 X Rs.1,00,000)/225
                                            =   Rs.57,777.7778/-

Joint Cost apportioned for A  =   (95 X Rs.1,00,000)/225
                                             =    Rs.42,222.2222/-

Apportionment of Joint costs Under Physical Units method

Same as in the previous period

In the above example there is no change in cost element involved in each product but joint cost apportionment varied. Friends in case of physical units method it takes an assumption that joint cost per unit of any product is same. Does these scenario`s justifiable?

In case of Adjusted NRV method impliedly it took the combined ratio of NRV price per unit of each product and ratio of units produced. But is it justifiable to take ration of which is based on selling price. Because selling prices of products and costs to produce such products does not have relation in all the cases.

Cost accounting standard specifies its objective as follows

“The objective of this standard is to bring uniformity, consistency in the principles, methods of determining and assigning Joint Costs with reasonable accuracy.”

It made me an impression that the word “reasonable” may not fulfilled by these two methods (Excluding Technical Estimate methods).

I got a solution, and my solution does not guarantee as a better solution than Technical Estimate method in most cases but fairly better than other two methods.

And my solution also depends on justification of the person dealing with this.

My preferred solution :

A. One must consider the cost per unit under adjusted NRV method (as done above)  in an Ideal year in which person of the opinion that it gives the most reasonable price (Say Adjusted NRV of Product P Rs.100 /- & Product Q Rs.50 /- ) .

B. Find the weight average change of joint cost in the required year (Say 5%)

C. Multiply A and B (Say Product P Rs.100 x 105% = Rs.105/- ; Product Q Rs.50 x 105% = 52.50/- ).

D. Take the ratio of products costs ( P : Q = 105 : 52.50 )

E. Take the ratio of production units ( If P = 1000 units and Q = 2000 units then P : Q = 1 : 2 )

F. Then take the combined ratio of D & E for apportionment of joint costs (i.e. P:Q = (105 x 1) : (52.50 x 2 )

In the above explanation one might take technical estimate to arrive the reasonable price as in point A instead of arriving values from Ideal year. Accuracy of soloution depends on Ideal Year determined if technical estimate is not take for this purpose. And one must take care of price specified in point A whenever there is change production process (Which may be due to technology changes or other). My preferred solution has the following merits than the other two methods (Excluding Technical Estimate method )

1. Apportionment of Joint costs does not depend on selling price.
2. It considers appropriate value to the quantities than physical units method.
3. Produces accurate cost calculation than other methods.
4. Cost of product will not be influenced by demand of output products.
5. Better assessment of cost of products.

Thanks for your attention,
D.VENKATA RAVI KISHORE
C.A FINAL STUDENT