By-Product Meaning, Features, Example, Accounting for By-products

By-product is a secondary product that is unintentionally or incidentally produced during the manufacturing of a main product or joint products. By-products usually have lower economic value compared to the main products and do not require separate production processes. They are often sold or reused to recover some part of the production cost. For example, in the sugar industry, molasses is a by-product obtained during sugar extraction from sugarcane. By-products can contribute to cost reduction and sustainability by minimizing waste and generating additional revenue from materials that would otherwise be discarded or underutilized.

Features of By-Product:

• Incidental Nature of Production

By-products are produced incidentally during the manufacturing of a main product or joint products. Their creation is not intentional or the primary goal of the production process. For example, in oilseed processing, oil is the main product, while oil cake is the by-product. These by-products emerge automatically as a result of chemical or physical reactions involved in the process. Companies do not set up production systems specifically for by-products, but they utilize or sell them if they hold commercial or economic value.

• Lower Economic Value

By-products generally have significantly less economic value compared to the main products. This lower value arises due to reduced demand, lower utility, or the fact that they are often waste or residue materials. While they may still generate some revenue, their contribution to overall profitability is usually minor. However, in large-scale operations, even the sale of by-products can offer noticeable financial benefits. For example, molasses in sugar production may not fetch high prices but can still offset processing costs if managed efficiently.

• Common in Process Industries

By-products are typically found in continuous or process industries where production involves chemical or mechanical transformations. Industries such as sugar, steel, paper, oil refining, and food processing often produce by-products. For instance, in the steel industry, slag and furnace gas are by-products generated during smelting. The nature of these industries makes it unavoidable to produce some amount of by-products. Their management becomes an integral part of production planning, especially when aiming for sustainability or cost-effectiveness.

• Cost Allocation Complexity

Allocating costs to by-products is complex because they are not the primary focus of production. Most companies do not allocate significant joint costs to by-products; instead, they may use methods like the net realizable value (NRV) or sales value at split-off for cost determination. Often, the income from selling by-products is treated as other income or used to reduce the cost of the main product, depending on accounting policies. This ensures accurate cost assessment without overburdening the main product.

• May Require Further Processing

Some by-products may need additional processing before they can be sold or used. This further processing adds extra cost but may significantly enhance the by-product’s value. For example, crude glycerin obtained as a by-product in biodiesel production can be purified for use in pharmaceuticals or cosmetics. Decisions regarding further processing depend on factors like market demand, processing cost, and profitability. In such cases, the by-product transitions closer to a co-product if its economic significance increases.

• Revenue Contribution

Though secondary, by-products can contribute to overall revenue. Especially in large-scale production, the cumulative value of by-products may offer substantial cost savings or profits. For instance, sawdust from wood processing can be sold to particleboard manufacturers. Revenue from by-products is often used to reduce the total cost of manufacturing or increase the profitability of the main product. Efficient utilization of by-products supports better financial performance and helps companies maximize their output value.

• Supports Environmental Sustainability

Utilizing by-products helps reduce industrial waste and promotes eco-friendly production practices. Instead of discarding them, businesses can find alternate uses, recycle them, or convert them into useful products. For example, rice husk, a by-product in rice milling, is used as biofuel or in construction materials. This reuse lowers environmental impact, aligns with sustainability goals, and improves a company’s green image. Effective by-product management also reduces disposal costs and aligns with circular economy practices.

Example of By-Product:

A common example of a by-product is molasses in the sugar industry. When sugarcane is processed to extract sugar, molasses is left behind as a thick, dark syrup. It is not the main objective of production but emerges naturally during the process. Although molasses has lesser value than sugar, it can still be sold or further processed to produce alcohol, ethanol, or animal feed. This helps sugar mills reduce waste, earn additional revenue, and increase overall production efficiency without incurring extra major production costs.

Accounting for By-Products Methods:

• Other Income Method

Under the Other Income Method, the by-product is not assigned any share of joint production cost. Instead, when it is sold, the income earned from the sale is treated as non-operating income or other income in the profit and loss account. This method is used when the by-product has very low value or is not significant to the main operations. The costs incurred on the by-product, if any, such as packaging or transport, are deducted from the sales value to arrive at net income. The method simplifies cost allocation but does not reflect true profitability of the process. It is suitable when the by-product is sold in small quantity or not directly linked to production decisions.

• Cost Reduction Method

In the Cost Reduction Method, the revenue from the sale of a by-product is deducted from the total cost of production of the main product. The by-product is not assigned a portion of the joint cost but is instead used to reduce the expense of the main product, thereby lowering the cost per unit of output. This method is suitable when the by-product has some economic value and is regularly generated. It is often preferred in manufacturing industries to reflect the real net cost of producing the main item. This approach is simple and helps managers assess the efficiency of the production process while accounting for all value-adding outputs.

• Net Realizable Value (NRV) Method

The Net Realizable Value (NRV) Method values the by-product based on its expected selling price minus any further processing or selling costs. The NRV of the by-product is then credited back to the joint production process, reducing the overall cost assigned to the main product. This method is useful when the by-product requires additional processing to be saleable. It gives a more realistic view of the benefit derived from by-products. NRV can vary based on market conditions, so estimates must be updated regularly. This method is widely accepted in accounting standards and reflects more accurate profitability when compared to simple cost reduction or other income methods.

• Market Value or Sales Value Method

The Market or Sales Value Method allocates joint costs to by-products proportionally based on their market or sales value at the split-off point. Both the main and by-products share a portion of the cost according to their ability to generate revenue. This method is especially useful when the by-product has a substantial value and is almost equal in importance to the main product. It ensures fair cost distribution, though it may require frequent updates due to market price fluctuations. This method aligns with the matching principle in accounting and presents a clearer picture of each product’s profitability. It is suitable for industries like petrochemicals or food processing.

• Replacement Cost Method

In the Replacement Cost Method, the value of the by-product is assessed based on the current market cost to replace the same material if it were to be purchased from an external source. This value is credited to the process account, and no joint cost is allocated directly. This method is used when the by-product is consumed internally, and the goal is to measure the cost-saving benefit from not having to purchase that material. It is commonly seen in industries using scrap or waste as fuel or raw material. The method is practical and efficient when actual market replacement prices are known and stable.

• Standard Cost Method

The Standard Cost Method assigns a pre-determined cost per unit to the by-product, based on historical data, estimates, or budgeted figures. This cost is used to value the by-product and is credited to the process account to reduce the cost of the main product. The method provides consistency and ease of calculation, particularly when by-products are consistently produced. However, it may not reflect current market trends unless the standard costs are revised periodically. This method is often used in internal reporting or budgeting where simplicity and predictability are needed, rather than accuracy in real-time financial results.

Accounting for By-products Journal entries: