In this article we will discuss about the meaning and accounting of by-products.
Meaning of By-Products:
CIMA define By-product as “output of some value produced incidentally in manufacturing something else (main product)”.
By-products may be defined as “any saleable or usable value incidentally produced in addition to the product.”
A by-product is a secondary product which incidentally results from the manufacture of main product and also from the same process. A by-product is a product which arises incidentally in the production of the main products and which has a relatively small sales value compared with the main products.
The distinguishing feature of by-product is its relatively low sales value in comparison to the main product. Like joint products, a by-product may need further processing after the point of separation before it is saleable.
The examples of process industries and their byproducts are given below:
Scrap and By-Product:
The distinction between scrap and by-product is a matter of degree determined in terms of value as well as manufacturing objective. Scrap is the incidental residue from the materials used in manufacturing operations which is recoverable and measurable without further processing.
The recoverable value of a by-product is relatively more than that of scrap. By-products may be subject to further processing and market strategy before sale, whereas scrap is sold without further treatment.
Waste is a term used to describe material that has no value, or even negative value if it has to be disposed off at some cost. Examples include gases, saw dust, smoke and other unsalable residues from the manufacturing process. Waste presents no accounting problems because it has no sales value, and therefore it is not included in the valuation stock.
Accounting for By-Products:
The methods of accounting for by-products are categorized into two:
(a) Cost methods, and
(b) Non-cost or sales value methods.
1. Opportunity or Replacement Cost Method:
This method is used when by-products are consumed in the same factory as raw material in place of existing material is in use. The cost of material replaced is considered as replacement or opportunity cost of the by-product and is credited to cost of production of main products.
The opportunity cost or replacement cost which otherwise would have been incurred if the by-products were to be purchased from outside suppliers, then such product will be valued at market value of like material.
2. Standard Cost Method:
The by-products are valued at a predetermined standard rate for each product which may be based on technical assessment. Standard cost of by-product is credited to the Process Account of the main product. This method makes it convenient to ascertain the cost of main product due to operational difficulties in computation of value of by-product.
3. Joint Cost Proration Method:
Where the by-products are having considerable commercial value or importance or where adoption of normal methods for by-product accounting may not be fair or reasonable to the main product or to the by-product, then the by-products will be treated as equal footing with the main products both for valuation and accounting of costs. The joint costs may be divided over joint products and by-products by using physical unit method (at the split-off point) or ultimate selling price (if sold).
Non-Cost or Sales Value Method:
1. Miscellaneous or Other Income Method:
When the market value of by-product is very small or negligible as compared to the main products, the sale value of by-product is shown as other income or miscellaneous receipt in the Profit and Loss Account.
This method of valuation is criticized for the following reasons:
(1) Valuation of stock of main products is inflated and no value is assigned to the by-product inventories.
(2) All costs and expenses charged to the main products is not scientific.
(3) No attempt is made to control the inventory of by-products and losses due to frauds are possible.
(4) By-products will be accounted only at the time of sale but not at the time of production. If sale of by-product is not effected within the period it is produced, profits vary between one period and another. This accounting treatment is highly objectionable.
2. Credit of By-Product Net Sale Value to Process Account:
In this method, the sale value of the byproducts will be credited to Process Account after deducting direct selling and distribution costs and other process costs incurred after point of separation and any special costs incurred on account of by-products. The main drawback in this method is any change in market value of byproduct will alter the cost of main products which will show deviation from standards set or previous costs incurred.
3. By-Product Sales deducted from Total Cost:
In this method, the sale value of by-product is deducted from the total cost. It may be deducted either from cost of production or cost of sales.
4. Credit of By-Product Value less Administration, Selling and Distribution Costs:
In this method, the sales value of the by-product, reduced by its portion administration, selling and distribution expenses incurred for its disposal, is credited to Process Account.
5. By-Product Sales added to the Main Product Sales:
In this method, all costs incurred on main and byproducts are deducted from the combined sales of the main product.
6. Reverse Cost Method:
In this method, the estimated profit from the sales of by-product, selling and distribution expenses and further processing costs after the split-off point are deducted from sales value of by-products and the net amount is credited to the main product.