The following points highlight the top two methods of accounting of by-products. The methods are: 1. Non-Cost or Sales Value Methods 2. Cost Methods.

#### 1. Non-Cost or Sales Value Methods:

(a) Other Income or Miscellaneous Income Method:

Accounting of by-products by this method is also inaccurate as there is a time lag between the sales and production. There is also a possibility that by-products may arise in one period but may be accounted in another period and thus distort the profits of two periods.

(b) By-Product Sales Added to the Main Product Sales:

Under this method, all costs incurred on main and by-products are deducted from the combined sales of the main product and by-products. This method is generally adopted in those cases where either the value of the by­products is very small or where the by-products are sold in the market in the state in which they emerge from the main product. By-products in stock are valued at nil value for balance sheet purpose.

(c) By-Product Sales Deducted from Total Cost:

Under this method, the sales values of by­products are deducted either from production cost or from the cost of sales. Fluctuating sales values of by-products also affect the costs of the main product and may encourage to conceal the inefficiencies therein. The stock in this case will be valued at total cost or cost of sales basis.

Illustration 1.

In a certain period 500 units of main product are produced and 400 units are sold at Rs.50 per unit. The by-product emerging from the main product is sold at Rs.1,000. The total cost of production of 500 units is Rs.15,000.

Calculate the amount of gross profit after crediting by-product value:

(a) To cost of production, and

(b) To cost of sales.

Solution:

Note the difference in the value of stock. It is Rs.2,800 in (a) method as against Rs.3,000 in (b) method. That is why there is a difference of Rs.200 in the gross profit.

(d) Credit of By-Product Value Less Selling and Distribution Costs:

Under this method, the selling and distribution costs incurred for selling the by-products are deducted from the sales value of by-products and the net amount is either credited to process account or is deducted from total cost. The closing stock of by-products is valued at selling price less an estimate of the costs likely to be incurred in selling the stock of by-products.

(e) Credit of By-Product Value Less Selling and Distribution Costs and Costs Incurred on By-Product after Split off Point:

Under this method, selling and distribution costs and costs incurred on further processing the by-products are deducted from the sale value of the by-products and net amount is credited to the process account. The closing stock of by-products is valued at selling price less an estimate of the costs likely to be incurred in selling and processing the stock of such by-products.

This method suffers from the disadvantage that if the market value of the by­product fluctuates, the credit to the Process Account of the main product will fluctuate accordingly owing Ito the fact that credit to the Main Product Process Account fluctuates, inefficiencies in that process may be concealed.

Illustration 2.

In the manufacture of main product, 200 units of a certain by-product were produced. The market value of the by-product was Rs.40 per unit. The by-product required further processing costs amounting to Rs.3,000 and selling and distribution overheads amounting to Rs.500 are incurred. Calculate the amount to be credited to the Process Account in respect of the by ­product.

Solution:

(f) Reverse Cost Method:

Under this method, an estimated profit from the sale of by­products, selling and distribution expenses and further processing costs after the split off point are deducted from the sales value of by-products and the net amount is credited to the main product.

Illustration 3.

In manufacturing the main product A a Company processes the resulting waste material into two by-products, B1 and B2. Using reverse cost method of by­products, prepare a Comparative Profit and Loss Statement of the three products from the following data:

Solution:

In order to ascertain comparative profit and loss, total cost up to separation point should be apportioned to main product A and by-products B1 and B2. Here Reverse Cost method is to be used.

Therefore, the main product A will bear Rs.58,400 (i.e. Rs.68,000 – Rs.4,800 – RS.4,800).

Illustration 4.

A factory is engaged in the production of a chemical X and in the course of its manufacture a by-product Y, is produced, which after a separate process has a commercial value. For the month of January 2007, the following are the summarized cost data:

The output for the month was 142 tonnes of X and 49 tonnes of Y and the selling price of Y averaged Rs.280 per tonne.

Assuming that the profit of Y is estimated at 50% of the selling price, prepare an account showing the cost of X per tonne.

Solution:

*The value of products (7 2,894) which Y By-product A/c has obtained from X Chemical (Main Product) to which all joint expenses have been debited, has been calculated as follows :

#### 2. Cost Methods:

(a) Opportunity Cost Method:

This method is used where by-products are utilized in the same undertaking as materials for some other process. The opportunity or replacement cost, i.e., the cost which could have been incurred had the by-products being used as materials could have been purchased from the market.

The process account is credited with the value of by-products so ascertained. For example, in the production of a main product a by-product X is obtained. In a certain period 400 units of by-product X are produced, which are transferred to another department where they are consumed.

If the by-products were purchased from the market, the price would be f 3 each. The amount to be credited to the main product in respect of by-product under this method is 400 units @ Rs.3 each = Rs.1,200.

(b) Standard Cost Method:

A standard cost may be fixed for each product by averaging the cost figures of the previous periods and the process account credited with this standard value. During the past five years records have been kept for the production costs of product C and product D which is a by-product of product C. These records show the following data in respect of product D:

The average cost per tonne is Rs.34,840 ÷ 670 = Rs.52. The standard cost of product D would be Rs.52. The standard cost should be revised new and then to give effect to change in actual cost. This method enables an effective control over the cost of the main product because of steady credit figures available in respect of by-product cost.

(c) Apportionment on Suitable Basis:

If the total value of by-products is considerable, their actual cost should be ascertained by apportioning the joint costs up-to the point of physical separation. The apportionment of joint cost is a complicated affair and involves the use of intricate calculations.

This method is followed where by-products are processed:

(i) To dispose of waste materials more profitably or

(ii) To utilize the idle plant.

In the first case, the by-product after separation is charged with overhead at full rate whereas in the second case it will include variable costs only.

Sales after further Processing or at the Split off Point:

Sometimes, it is to be decided whether a product should be sold at split off point or it should be further processed in order to maximize the profit of the concern. In such cases, the alternative which gives more profit (i.e., incremental revenue—incremental cost) must be adopted. This will be more clear from the following illustration.

Illustration 5.

A manufacturing company engaged in process industry gets four joint products from one of its operations. The cost of input amounted to Rs.2,33,250. These products can be sold at the split-off point or after further processing. Further details are given below:

Which of the products have to be processed further and sold?

Prepare a Cost Sheet and Profitability Statement apportioning joint cost on the basis of relative sale value.

Solution:

Hence, it is not advisable to Process C further. The relative sale value of the products at split off point and allocated joint cost incurred before separation are worked out below: