In: Accounting
Which of the two common approaches used to account for by-product/scrap provides better information to management? Discuss the rationale for your answer.
One approach is to ignore by-product inventory completely until it is sold. Only then does the revenue it generates acknowledge the existence of the by-product. This revenue is carried to the income statement as an increase to net income of the period. The second approach is to record, at the split-off point, the final net realizable value of the by-product recovered. The net realizable value is credited as a reduction of the joint process costs that gave rise to the by-product. The second approach is theoretically preferable because it causes the benefit to be matched with the source of the benefit – namely, the joint process costs being incurred during the period.
(1) One approach is to ignore by-product inventory completely until it is sold. (2) The second approach is to record, at the split-off point, the final net realizable value of the by-product recovered.