Question

Briefly explain how different types of cost allocation methods like Physical measure (Physical units) method, Sales value at split off method, Net Realizable Value (NRV) method and constant gross margin percentage NRV method of Management Accounting can be applied to education industry while allocating overhead cost among different cost objects. Give an example by taking the values arbitrarily (real data not required). 1st explain different cost objects or departments to allocate costs and then allocate using these 4 methods.

Answer 1

Joint Costs is the assembling cost acquired on a joint creation process that takes normal sources of info however all the while produces different items called joint-products e.g. preparing of raw petroleum all the while yields gas, diesel, stream fuel, greases, and different items.

So as to allot expenses to such joint items, bookkeepers need to utilize an appropriate cost designation technique on a reliable premises. Generally normal of those techniques are:

Physical Measurement Method

Joint costs are allocated based on the number of units or physical quantity such as weight, volume or length of each product relative to total production. This method can be represented in the following formula:

Cost Allocated to a Joint Product = Quantity of the Product / Quantity of Total ProductionTotal Joint Costs

This method is suitable where the physical quantity of joint-products closely reflects their costs e.g. different shades of paint obtained from a single process may be allocated costs using the physical quantity method.

Relative Sales Value Method

This method allocates joint costs on the basis of the estimated sales value of a given joint product relative to the sales value of total joint production. This is illustrated in the following formula:

Cost Allocated to a Joint Product = Sale Value of the Product / Sales Value of Total ProductionTotal Joint Costs

This method is suitable when the physical quantity of joint products does not reflect their value and a reliable estimate of their sale value can be easily made.

Net Realizable Value (NRV) Method

For products that need further processing, NRV method is more suitable because it takes into account, the additional costs needed to further process and sell the joint products. Under this method, joint cost is allocated to products using the following formula:

Cost Allocated to a Joint Product - NRV of the Product / NRV of Total ProductionTotal Joint Costs

Where,
NRV = Estimated Sales Value − Estimated Cost to Further Process and Sell

When such products are further processed after split-off, their total costs also include further processing costs.

Example

Use the following data relating to two chemicals A and B obtained from a joint process and allocate joint costs using each of the above methods.

Chemical	A	B
Quantity (kg)	80	125
Sale Value	$15,000	$60,000
Further Processing Cost	$4,000	$2,000

The total manufacturing cost of the joint process was $30,000.

Solution

Cost to be allocated to chemical A:

Physical Measurement Method	30,000×80÷(80+125)	11,707
Relative Sales Value Method	30,000×15,000÷(15,000+60,000)	6,000
NRV Method	30,000×11,000÷(11,000+58,000)	4,783

Where, 11,000 = 15,000 − 4,000 and 58,000 = 60,000 − 2,000

Now that we have estimated cost of Chemical A and there are just two products, we can calculate the cost to be allocated to chemical B just by subtracting the above costs from the total under each method respectively as shown below:

Cost to be allocated to chemical B:

Physical Measurement Method	30,000−11,707	18,293
Relative Sales Value Method	30,000−6,000	24,000
NRV Method	30,000−4,783	25,217