Question

1) Syarikat Sabah prepares lumber for companies who manufacture furniture

(a) The main product is finished lumber with a byproduct of wood shavings. The byproduct is sold to plywood manufacturers. For July, the manufacturing process incurred RM332,000 in total costs. 80,000 board feet of lumber were produced and sold along with 6,800 kg of shavings. The finished lumber sold for RM6.00 per board foot and the shavings sold for RM0.60 a kg. There were no beginning or ending inventories.

Required:

Prepare two statements of financial position as at 31 December 2019 showing the byproduct as a cost reduction during production, and as a revenue item when sold each

(b) Distinguish and briefly discuss the merits [or demerits] between the two principal methods of accounting for byproducts: the production byproduct method and the sale byproduct method.

(c) Identify the revenue or expense amounts necessary to make a sell-or-process-further decision and the reasons behind them

(d) Identify the four methods of allocating joint costs to individual products and the most preferred method among accountants.

Answer 1

a. Please see attached solution

b. Production Method of Accounting

The production method of accounting for byproducts has the following features.

1. The byproduct is recognized in the accounting period in which it is produced.

2. Production costs equal to the net realizable value (NRV) of the byproduct are allocated to the byproduct.

3. The effect of this allocation is to reduce the net production cost of the main product.

4. The byproduct is included as part of the inventory of the business.

5. When the byproduct is sold, since its sales value and cost are both equal to the NRV, the profit on the sale is zero.

Sales Method of Accounting

The sales method of accounting for byproducts has the following features.

1. The byproduct is only recognized in the accounting period in which it is sold.

2. Production costs are not allocated to the byproduct.

3. The byproduct is not held as inventory.

4. The net realized value (sales value) of the byproduct when it is sold is included in the revenue or sundry income of the business.

5. Since the costs allocated to the byproduct are zero, the profit on disposal is equal to the sales value.

The by-product production and sales methods both fail to comply with GAAP as production costs are not properly allocated to the by-product. The proper method would be to treat the by-product equally with the main products from the process i.e as a joint product. Due to the minimal value of the by-product, an analysis would show that the costs of complying with GAAP would far outweigh the benefits of doing so.

c. In a sell or process further decision, management should process when:

The additional revenue is more than the additional process cost. We may need to have a proper contract with customers to lock the price.

The additional profit margin should be equal or higher than the original margin. We may process with a lower margin when the company has surplus cash available.

We have enough resources to complete the additional work.

d.The four methods of allocating joint costs to individual products and the most preferred method among accountants.

1. Market or sales value method

The market or sales value method allocates a joint production cost on the basis of relative market or sales values of individual joint products.

2. Quantitative or physical unit method

This method uses some physical measurement units (such as volume, weight etc.) to allocate joint production cost.

3. Average unit cost method

The average unit cost method, as the name implies, uses average unit cost to allocate the cost before split-off point.

4. Weighted average method

This method assigns predetermined weight factors to joint products based on various factors such as price, production complexity and unit size of the product.

Explanation: