Allocating Joint Costs

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Allocating Joint CostsDescribe the three methods used to allocate joint costs.What are the advantages/disadvantagesof each allocation method?Which method would you recommend?Why?Support yourposition with evidence from the text or external sources.Your initial post should be 200-250words.There are three methods of allocating joint costs.The first method is thephysical measures ofoutput, where joint costs are allocated in proportion to a respective product’s output measure(Schneider, 2012).Essentially, if there is product A, B, and C, the allocation to product A wouldbe(A / (A + B + C)) * Total Costs.The advantage of this method is the simplicity of the design.However, there are numerous disadvantages.First, the outputs could have different units of measurement (Schneider, 2012).For instance, oneproduct may be measured by tons, while another is measured by gallons.Second, the physicalmeasures of output may be unrelated to the profitability of the other joint products (2012).Forexample, suppose a factory uses corn to make animal feed, seed, canned corn, and ethanolproducts.Based on production, animal feed may have the most costs allocated and ethanol thelowest; but based on revenue, ethanol may make the most money and animal feed the least.Thus, since ethanol is the motivating factor to spend, it should have more costs allocated to it(2012).Essentially, thephysical measures of outputmethod do not take into account therevenue-producing ability of each product (Fabozzi, Polimeni, & Drake, 2008).If the allocationis based solely on pounds, technically one pound of seed would have the same unit cost as onepound of canned corn, even though one brings in more revenue than the other (2008).The second method isrelative sales value; joint costs are allocated in proportion to total salesvalues at the split-off point (Schneider, 2012).The advantage of this theory is that the revenueportion lacking from the previous method is now addressed.Furthermore, analysts argue sincethe price of a product is driven by the cost to create the product, then the revenues made off theproduct should be addressed in allocating joint costs (Fabozzi, Polimeni, & Drake, 2008).Apotential disadvantage of the method is sales prices may not be readily available, and there maynot be a market for one of the joint products at the split-off point (2012).Thus, the final method is thenet realizable value(NRV), where approximations of the salesvalue are used, and then total sales revenue minus separable costs equal NRV (Schneider, 2012).The advantage of this method is it addresses the weaknesses ofboththephysical measures ofoutputandrelative sales value methods.Furthermore, the method addresses raw materials asthe split-off point, so the proper product (that with highest revenues) is appropriately allocatedthe most costs (Fabozzi, Polimeni, & Drake, 2008).However, the disadvantages of the methodare fluctuations in market value can create fluctuation in costs assigned even though productionhas not changed, and also the fact that sales revenues are beingassumedrather than known(2008).So which method should be recommended?I would recommend the relative sales value for numerous reasons.First, the approach allocatesthe costs based on proportion of sales (Schneider, 2012).This eliminates the problem of a rawmaterial splitting-off and becoming one product of ‘pounds’ and another of ‘gallons’.Second,the product which has the highest revenue receives the majority of the joint cost allocations,which is logical since a firm is going to invest more direct materials, direct labor, and overheadinto the more profitable product (Fabozzi, Polimeni, & Drake, 2008).Finally, Davis (2011)argued the method allows for an even representation of expected gross profits, as the proportions

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