Managerial Accounting

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Allocation of Joint Production Costs

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Managerial Accounting

Assignment No. 2

MBA-2

Hunain Aziz AM 551522 Banking & Finance

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Acknowledgement
I would like to thank Mr. Javed Islam and Mr. Naqqash Majeed, who have helped me to collect important information about the company. Without their cooperation and assistance, it would not be possible for me.

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Table of Contents
Allocation of Joint Production Costs…………………………………………………………....4 Introduction………………………………………………………….…….…………..…….…4 By Products and Joint Products………………………………………….………...…….….….4 Nature of By-Products……………………………………………………………...….….……5 Difficulties in costing……………………………..……………………………………………6 Methods of Allocating Joint Product Costs………………………………………………..…...7

Practical Study of Organization…………………………………………………………….....10 History………………………………………………………………………….………….….10 Target Market………………………………………………………………………………....10 Products…………………………………………………………………………………….....10 Exports………………………………………………………………………………..…..…...11 Ingredients………………………………………………………………………………….…11 Processing…………………………………………………………………………….….…...11 Advantages……………………………………………………….…………………………..12 Allocation of Costs…………………………………………………………….…….……..…13 Conclusion and Recommendation……………………………………………..……….….…16 References………………………………………………………………………………….....16

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Allocation of Joint Production Costs
Introduction
Many industrial concerns are confronted with the difficult and often rather complicated problem of assigning costs to their by-products and joint products. Chemical companies, coke manufacturers, refineries, flour mills, coal mines, lumber mills, gas companies, dairies, canners, meatpackers, and many others produce in their manufacturing or conversion processes a multitude of products to which some cost must be assigned. Assignment of costs of these various products enhances equitable inventory costing for income determination and financial statement purposes. An even more important aspect of by product and joint product costing is that it furnishes management with data for use in planning maximum profit potentials and evaluating actual profit performance.     Difficulties in costing by products and joint products Joint Products and Joint Product Costs Characteristics of Joint Products and Cost By Products

By-Products and Joint Products Defined
The term by-product is generally used to denote a product of relatively small total value produced simultaneously with a product of greater total value. The product with the greater value, commonly called the main product, is usually produced in greater quantities than the byproducts. Joint products are produced simultaneously by a common process or series of processes, with each product possessing more than nominal value in the form in which it is produced. The production is simultaneous because the manufacturing process inevitabily creates all the products.

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Nature of By-Products:
The accounting treatment of by-products necessitates a reasonably complete knowledge of the technological factors underlying their manufacture, since the origins of by products may vary. By-products arising from the cleansing of the main product, such as gas and tar from coke manufacture, generally have a residual value. In some cases, the by product is left over scrap or waste, such as saw dust in lumber mills. In other cases, the by product may not be the result of any manufacturing process but may arise from preparing raw materials before they are used in the manufacture of the main product. The separation of cotton seed from cotton, cores and seeds from apples, and shells from cocoa beans are examples of this type of product. By product can be classified into the following two groups according to their marketable condition at the split-off point:   Those sold in their original form without need of further processing. Those which require further processing in order to be saleable.

Joint Costs
A joint cost can be defined as the cost that arises from the simultaneous manufacturing of products produced from the same process. Whenever two or more different joint or by-products is created from a single resource, a joint cost results. A joint cost is incurred prior to the split-off point.

Joint product cost
A joint product cost can be defined as that cost which arises from the common processing products produced from a common raw material. Whenever two or more different products are created from a single cost factor, a joint product cost results. A joint cost is incurred prior to the point at which separately identifiable products emerge from the same process.

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Difficulties / Problems in Costing by Products and Joint Products:

By products and joint products are difficult to cost because a true joint cost is indivisible. For example, an ore might contain both lead and Zink. In the raw state, these minerals are joint products, and until they are separated by reduction of the ore, the cost of finding mining and processing is a joint cost; neither lead nor Zink can be produced without the other prior to the split-off point.

The cost accumulated to the split-off point must be borne by the difference between the selling price and the cost to complete and sale each mineral after the split-off point.

Joint costs are frequently confused with common costs. However, there is a significant difference between the two: a joint cost is indivisible and common costs are divisible. Common costs are allocable among products or service. Because each of the product or service could have been obtained separately. Therefore, any shared costs of obtaining them can be allocated on the basis of relative usage of common facilities. For example, the cost of fuel or power may be allocated to products on the basis of production volumes or metered usage. The indivisibility characteristics of a joint cost are not always easy to comprehend, since in some cases a cost can be divided among joint products in accordance with a common cost causing characteristic. However the results of such divisions of limited use to management for decision making.

Because of the indivisibility of a joint cost, cost allocation and apportionment procedures used for establishing the unit cost of a product are far from perfect and are, indeed, quite arbitrary. The costing of joint products and by products highlights the problem of assigning costs to products whose origin, use of equipment, share of raw materials, share of labor costs, and share of other facilities cannot truly be determined

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Methods of Allocating the Joint Production Cost

The allocation of joint product cost incurred up to the split-off point can be made by:

1. The market or sales value method, based on the relative market values of the individual products. 2. The quantitative or physical unit method, based on some physical measurement unit such as weight, linear measure, or volume. 3. The average unit cost method. 4. The weighted average method, based on a predetermined standard or index of production.

 Market or Sales Value Method--Allocation of Joint Cost

Market or sales value method enjoys great popularity because of the argument that market value of any product is a manifestation of the cost incurred in its production. The contention is that if one product sells for more than another, it is because more cost was expended to produce it. Therefore, the way to prorate the joint cost is on the basis of the respective market values of the items produced. The method is really a weighted market value basis using the total market or sales value of each unit (quantity sold times the unit sales price).

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 Quantitative or Physical Unit Method--Allocating Joint Product Cost
Quantitative or physical unit method attempts to distribute the total joint cost on the basis of some unit of measurement, such as pounds, gallons, tons, or board feet. Of course, the unit products must be measurable by the basic measurement unit. If this isn't possible, the joint units must be converted to a denominator common to all units produced, For example, in the manufacture of coke, products such as coke, coal tar, benzyl, sulfate of ammonia, and gas are measured in different units. The yield of these recovered units is measured on the basis of the quantity of product extracted per ton of coal.

 Average Unit Cost Method--Allocating Joint Product Cost

Average unit cost method attempts to apportion total joint production cost to the various products on the basis of a predetermined standard or index of production. An average unit cost is obtained by dividing the total number of units produced into the total joint production cost. As long as all units produced are measured in terms of the same unit and do not differ greatly, the method can be used without too much misgiving. When the units produced are not measured in like terms, the method cannot be applied.

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 Weighted Average Method--Allocating Joint Product Cost

Many industries, the previously described methods do not give a satisfactory answer to the joint cost apportionment problem. For this reason, weight factors are often assigned to each unit, based upon size of the unit, difficulty of manufacture, time consumed in making the unit, difference in type of labor employed, amount of materials used etc. Finished production of every kind is multiplied by weight factors to apportion to total joint cost to individual units.

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Practical Study of Organization

Acp Oil Mills (Pvt) Ltd.
History
ACP oil mills were established in year 1992 by Haji Abdul Latif. It is situated in industrial sector of Islamabad. ACP is well known for its products in Rawalpindi and Islamabad. The company is successfully running the business of oil manufacturing for past 20 years. The company has one production plant which is situated in I/9 Industrial area of Islamabad. Relatively low prices of ACP products have made the company sales to increase.

Target Market of ACP
1 Middle and Low class group 2 Health conscious 3 Market of Twin cities

Products
    ACP Cooking Oil ACP Banaspati Ghee Dil Pasand Ghee Dil Pasand Cooking Oil

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Ingredients of Cooking Oil
Ingredients of cooking oil are canola oil, soya bean, sunflower seed, caustic soda, bleaching earth, citric acid.

Ingredients of Vanaspati Ghee
Palm, soybean, rapeseed and cottonseed oils are the most commonly used oils for Vanaspati ghee.

Exporting Business
ACP oil mills are also exporting its oil and ghee products to several south East Asian and Middle East countries like Malaysia, Thailand, and Sharjah etc.

Ingredients
Vegetable ghee is basically a vegetable oil m a d e i n t o s o l i d t o i m i t a t e t h e characteristics (flavor, texture, etc.) of butter oil (butter without its water). It ist h u s c o m p r i s e d a l m o s t w h o l l y o f a vegetable oil or a mixture of vegetable o i l s . O t h e r i n gr e d i e n t s l i k e f l a v o r , color, vitamins and antioxidants may be added depending on the food regulations in the country in which the product is sold.

Processing
Traditionally, hydrogenation is used to raise the melting range of liquid oil so that the oil becomes solid at room temperature. However, transfatty acids a r e a n i n a d v e r t e n t r e s u l t o f p a r t i a l hydrogenation and, as they pose a health risk, the current effort is to reduce or e l i m i n a t e t h e u s e o f h y d r o g e n a t i o n process. The trend today is to use formulations that are free from transfatty acids. Either direct blending or interesterification of o i l s a n d f a t s u s i n g p a l m o i l a n d i t s products as the major components will achieve this (see Processing Steps).

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Advantages of Using Palm Oil and Its Products
1. Naturally semi-solid oil Palm oil and palm stearin have natural solids content and therefore require no hydrogenation. The products are thus free from transfatty acids

2. Lower cost of production W i t h o u t h yd r o g e n a t i o n , t h e c o s t o f production is significantly lower. The s a v i n g s c a n b e p a s s e d o n t o t h e consumers to encourage sales.

3. Availability of palm oil and palmstearin Oil palm yields throughout the year, and a supply of good quality palm oil and palm stearin, especially from Malaysia, is available at all times of the year. It is p o s s i b l e t o r e q u e s t c u s t o m i s e d p a l m stearin with specific physic-chemical characteristics for various formulations.

Competitors
The competitors of ACP Oils are     Latif Ghee Man Pasand Ghee Mujahid Ghee Pakwan oil

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Allocation of Joint Costs in ACP
The method used by ACP oil is the Market Value Method. They allocate the joint production cost by using this method.

Market Value Method

Market or sales value method enjoys great popularity because of the argument that market value of any product is a manifestation of the cost incurred in its production. The contention is that if one product sells for more than another, it is because more cost was expended to produce it. Therefore, the way to prorate the joint cost is on the basis of the respective market values of the items produced. The method is really a weighted market value basis using the total market or sales value of each unit (quantity sold times the unit sales price).

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Joint Product Cost Analysis for Managerial Decisions and Profitability Analysis

Companies generally resist such requirements. One of their main arguments is that cost allocation today is fraught with great danger of improper interpretation caused by an arbitrary allocated joint cost. Of course, there are acceptable ways of allocating joint product cost. Thus the choice of method makes a difference. The decision determines the degree of profitability of the various individual products.

Joint cost allocation methods indicate only too forcefully that the amount of the cost to be apportioned to the numerous products emerging at the point of split-off is difficult to establish for any purpose. Furthermore, the acceptance of an allocation method for the assignment of the joint production cost does not solve the problem. The thought has been advanced that no attempt should be made to determine the cost of individual products up to the split-off point: rather, it seems important to calculate the profit margin in terms of total combined units. Of course, costs incurred after the split-off point will provide management with information needed for decisions relating to the desirability of further processing to maximize profits.

Production of joint products is greatly influenced by both the technological characteristics of the processes and by the markets available for the products. This establishment of a product mix which is in harmony with customer demands appears profitable but is often physically impossible. It is interesting to note that cost accounting in the meat packing industry serves primarily as a guide to buying, for aggregate sales realization values of the various products that will be obtained from cutting operations are considered in determining the price that a packer is willing to pay for livestock. Sales realization values are also considered when deciding to sell hams or other cuts in a particular stage or to process them further.

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A joint cost is often incurred for products that are either interchangeable or not associated with each other at all. Increasing the output of one will in most joint cost situations unfavorably increase to some extent the output of the other. These situations fall into the category of the costvolume-profit relationship and differential cost analysis. Evaluation of many alternative combinations of output can lead to time consuming computations. Often such evaluations are carried out on a computer using sophisticated simulation techniques. Development in operations research procedures has provided techniques helpful in solving such problems (linear programming technique). For profit planning, and perhaps as the only reliable measure of profitability, management should consider a product's contribution margin after separable or individual costs are deducted from sales. This contribution margin allows management to predict the amount that a segment or product line will add to or subtract from company profit. This margin is not the product's net profit figure. It indicates relative profitability in comparison with other products. "Net profit determined by allocating to segments an equitable share of all costs, both separable and joint, associated with the group of segments not a reliable guide to profit planning decisions because these data cannot be used for predicting the outcome of decisions in terms of the change in aggregate net profit." For those reasons, attempts to allocate joint marketing cost to products and customers by time studies of salespersons' activities, as well as attempts to allocate the joint cost, often yield results which are unreliable for appraising segment profitability.

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Conclusion & Recommendation

The overall management of ACP oills is very good and they have an efficient cost allocation control system. The overall inventory costs are under control and company is well on the way to efficient control system resulting in the increase sell and overall expansion. I would recommend the company not to hold too much inventory as it can cause them a loss due to instability in the prices of raw material.

References

http://en.wikipedia.org/wiki/Vegetable_oil http://accounting4management.com/joint_product_analysis_for_managerial%20_decisions.htm

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