by In many manufacturing and agricultural businesses, several products are produced simultaneously from a common process. The costs incurred up to the point where these products become separately identifiable are known as common costs or joint costs. Since these costs are incurred for all products together, they cannot be directly assigned to any single product. Therefore, it becomes necessary to apportion the common costs and revenues among the various products to determine the cost and profitability of each product.
Product costing involves assigning costs to individual products so that the cost of production and profit earned from each product can be determined accurately.
Meaning of Common Cost
Common costs are costs incurred jointly for producing two or more products and cannot be directly identified with any specific product.
Examples
- Cost of cultivating crops producing multiple outputs.
- Cost of processing crude oil into various petroleum products.
- Cost of raising livestock that produces milk and manure.
- Cost of processing sugarcane into sugar and molasses.
Meaning of Revenue Apportionment
Revenue apportionment refers to the allocation of total sales revenue among joint products or departments for determining the profitability of each product.
Need for Apportionment of Common Costs and Revenue
- To determine the cost of individual products.
- To ascertain product-wise profitability.
- To fix selling prices.
- To evaluate performance.
- To prepare financial statements.
- To make production decisions.
Methods of Apportioning Common Costs by Product Costing
1. Physical Units Method
Formula: Cost Allocated to Product = (Units of Product / Total Units) × Common Cost
Example
A common cost of ₹1,20,000 is incurred to produce:
| Product | Units |
|---|---|
| A | 600 |
| B | 400 |
| Total | 1,000 |
Allocation:
- Product A = ₹72,000
- Product B = ₹48,000
Features
- Based on physical quantity of output.
- Simple and easy to understand.
- Suitable for similar products.
- Ignores selling price differences.
- Easy to calculate and apply.
- Useful where products are homogeneous.
2. Sales Value at Split-Off Method
Under the Sales Value at Split-Off Method, common costs are apportioned according to the relative sales value of each product at the point where the products become separately identifiable. The method assumes that products generating higher revenue should bear a larger proportion of the common costs. It is widely used because it considers the economic value of each product and provides a fair basis for cost allocation. This method is especially suitable when products have different selling prices and are sold immediately after the split-off point. However, it becomes less effective when market prices fluctuate significantly or when products require further processing after separation.
Example
| Product | Sales Value (₹) |
|---|---|
| A | 3,00,000 |
| B | 2,00,000 |
Common Cost = ₹1,00,000Allocation:
- Product A = ₹60,000
- Product B = ₹40,000
Features
- Based on relative sales value.
- Considers economic importance of products.
- Suitable for products with different prices.
- Widely used in practice.
- Provides equitable cost allocation.
- Affected by market price changes.
3. Net Realizable Value (NRV) Method
The Net Realizable Value Method allocates common costs based on the net value that each product is expected to realize after deducting further processing costs and selling expenses. This method is particularly useful when joint products require additional processing before they can be sold. It provides a realistic basis for cost allocation because it considers both the selling price and additional costs incurred after the split-off point. The method helps determine the actual profitability of products and supports managerial decision-making. However, it relies on estimates of future costs and selling prices, which may reduce the accuracy of the allocation.
Formula: NRV = Selling Price − Further Processing Cost
Example
| Product | Selling Price | Further Cost | NRV |
|---|---|---|---|
| A | ₹3,00,000 | ₹50,000 | ₹2,50,000 |
| B | ₹2,00,000 | ₹20,000 | ₹1,80,000 |
Features
- Based on net realizable value.
- Suitable for further processed products.
- Considers future processing costs.
- Provides realistic allocation.
- Helps determine profitability.
- Depends on estimates and assumptions.
4. Average Cost Method
The Average Cost Method allocates common costs by dividing the total common cost by the total number of units produced. The resulting average cost per unit is then assigned equally to all products. This method is simple and easy to apply and is suitable when products are similar in nature and have comparable values. It avoids complicated calculations and provides a uniform cost for all units produced. However, the method does not consider differences in product quality, market value, or profitability. Consequently, it may not provide an accurate measure of product costs when products differ significantly from one another.
Formula: Average Cost Per Unit = Total Common Cost / Total Units Produced
Example
Common Cost = ₹90,000
Total Output = 900 unitsAverage Cost per Unit:₹90,000 ÷ 900 = ₹100 per unit.Features
- Based on average cost per unit.
- Simple and easy to compute.
- Suitable for homogeneous products.
- Ignores value differences.
- Provides uniform cost allocation.
- Less suitable for diverse products.
5. Constant Gross Margin Percentage Method
The Constant Gross Margin Percentage Method allocates common costs in such a way that all products earn the same percentage of gross profit. Under this approach, the total gross margin is calculated first and then distributed among products proportionately. This method is considered useful because it reflects profitability and provides a consistent profit percentage across all products. It is particularly beneficial for managerial decision-making and performance evaluation. However, the calculations involved are relatively complex and require accurate information regarding sales values and additional processing costs. Therefore, the method is generally used by larger organizations with sophisticated accounting systems.
- Based on uniform gross profit percentage.
- Considers profitability of products.
- Useful for managerial decisions.
- Provides consistent profit margins.
- Requires detailed calculations.
- Suitable for complex production processes.
6. Contribution Margin Method
The Contribution Margin Method allocates common costs on the basis of the contribution generated by each product. Contribution is calculated by deducting variable costs from sales revenue. Products that generate a higher contribution are allocated a larger share of the common costs because they contribute more towards covering fixed costs and earning profits. This method is useful for managerial decision-making, product evaluation, and determining the profitability of different products. It helps management identify high-performing products and make decisions regarding pricing, production, and resource allocation. However, the method requires accurate classification of costs into fixed and variable categories, which may sometimes be difficult in practice.
| Product | Sales (₹) | Variable Cost (₹) | Contribution (₹) |
|---|---|---|---|
| A | 2,00,000 | 1,20,000 | 80,000 |
| B | 1,50,000 | 1,00,000 | 50,000 |
Common costs are apportioned in the ratio of contributions (80,000 : 50,000).
- Based on contribution margin.
- Helps determine product profitability.
- Useful for managerial decisions.
- Assists in pricing decisions.
- Requires cost classification.
- Suitable for profit analysis.
7. Weighted Average Method
Under the Weighted Average Method, common costs are allocated by assigning different weights to products based on factors such as quantity, quality, market value, or importance. Each product receives a proportion of the common cost according to its assigned weight. This method is useful when products differ significantly in value or characteristics and a simple physical units method may not provide fair results. The method provides flexibility because management can choose appropriate weights according to the circumstances. However, the selection of weights is subjective and may differ from one organization to another, affecting the reliability of cost allocation.
| Product | Units | Weight |
|---|---|---|
| A | 500 | 3 |
| B | 500 | 2 |
The common cost is allocated in the ratio of weighted units (1500 : 1000).Features
- Based on assigned weights.
- Suitable for different types of products.
- Provides flexible cost allocation.
- Considers product importance.
- More realistic than simple quantity methods.
- Involves subjective judgment.
8. Market Value Method
The Market Value Method apportions common costs according to the current market value of each product. Products having higher market values are allocated a larger proportion of the common costs. This method recognizes the economic significance of each product and provides a fair basis for allocation when market values are readily available. It is widely used in industries where products have significantly different selling prices and market demand. However, frequent changes in market prices may affect the stability and accuracy of cost allocation.
| Product | Market Value (₹) |
|---|---|
| A | 4,00,000 |
| B | 2,00,000 |
Common costs are allocated in the ratio of 4:2 or 2:1.
- Based on market value of products.
- Considers economic importance.
- Suitable for products with different prices.
- Helps determine product profitability.
- Easy to understand and apply.
- Affected by market fluctuations.
9. Survey Method
The Survey Method allocates common costs based on technical surveys and expert opinions. Under this method, specialists study the production process and estimate the proportion of common costs that should be assigned to each product. This method is particularly useful when other methods cannot be applied due to the absence of reliable quantitative or financial data. Although the method provides flexibility, it involves personal judgment and may therefore lead to bias or inconsistency in cost allocation.
- Based on expert opinion and surveys.
- Useful when other methods are unsuitable.
- Flexible in application.
- Considers technical factors.
- Involves subjective judgment.
- May lead to inconsistent allocations.
10. Standard Cost Method
The Standard Cost Method allocates common costs on the basis of predetermined standard costs established for each product. Standards are set after considering expected material, labour, and overhead requirements. Common costs are then distributed according to these standard costs. This method is useful for cost control and performance evaluation because actual costs can be compared with standard costs to identify variances. However, establishing accurate standards requires detailed analysis and periodic revision, making the method more suitable for large organizations.
Example: If standard cost ratios are determined as Product A – 70% and Product B – 30%, common costs are allocated accordingly.
Features
- Based on predetermined standards.
- Useful for cost control.
- Assists in performance evaluation.
- Facilitates variance analysis.
- Requires periodic revision of standards.
- Suitable for large organizations.
Methods of Revenue Apportionment
Revenue apportionment refers to the process of allocating total revenue among different products, departments, branches, or joint products on a reasonable basis. It is particularly important in joint product costing, where two or more products are produced simultaneously from a common process. Proper revenue apportionment helps determine product-wise profitability, evaluate performance, and support managerial decision-making.
The following are the major methods of revenue apportionment:
1. Sales Value Method
Under the Sales Value Method, total revenue is apportioned according to the relative selling value of each product. Products with higher sales values receive a larger share of the total revenue.
This method is widely used because it considers the economic value of products and provides a fair basis for revenue allocation. It is suitable when products have different market prices and are sold immediately after production.
Example
| Product | Sales Value (₹) |
|---|---|
| A | 4,00,000 |
| B | 2,00,000 |
| Total | 6,00,000 |
Revenue ratio = 4,00,000 : 2,00,000 = 2 : 1.
- Based on selling price.
- Considers economic importance.
- Simple and practical.
- Suitable for products with different values.
- Widely used in joint product costing.
- Affected by market price changes.
2. Quantity or Physical Units Method
Under this method, revenue is apportioned according to the physical quantity of products produced, such as kilograms, litres, units, or tonnes.
The method assumes that each unit contributes equally to total revenue. It is simple and easy to apply but may not provide fair results when products differ significantly in market value.
Example
| Product | Quantity Produced |
|---|---|
| A | 600 units |
| B | 400 units |
| Total | 1,000 units |
Revenue is apportioned in the ratio of 600:400 or 3:2.
Features
- Based on physical output.
- Easy to calculate.
- Suitable for similar products.
- Ignores market value differences.
- Provides simple allocation.
- Useful for homogeneous products.
3. Contribution Margin Method
The Contribution Margin Method allocates revenue based on the contribution generated by each product. Contribution is calculated by subtracting variable costs from sales revenue.
Products that generate higher contributions receive a larger share of the revenue because they contribute more toward fixed costs and profits.
Example
| Product | Contribution (₹) |
|---|---|
| A | 1,20,000 |
| B | 80,000 |
Revenue is apportioned in the ratio of 1,20,000 : 80,000 or 3:2.
Features
- Based on contribution generated.
- Helps measure profitability.
- Useful for decision-making.
- Assists in product evaluation.
- Requires cost classification.
- Suitable for profit analysis.
4. Net Realizable Value (NRV) Method
Under this method, revenue is apportioned according to the net realizable value of each product after deducting further processing costs and selling expenses.
This method is particularly useful when products require additional processing before sale.
Formula: NRV = Selling Price − Further Processing Costs − Selling Expenses
Example
| Product | Selling Price | Further Cost | NRV |
|---|---|---|---|
| A | ₹3,00,000 | ₹50,000 | ₹2,50,000 |
| B | ₹2,00,000 | ₹20,000 | ₹1,80,000 |
Revenue is apportioned in the ratio of NRVs.
Features
- Based on net realizable value.
- Suitable for further processed products.
- Considers additional costs.
- Provides realistic allocation.
- Helps determine profitability.
- Depends on estimates.
5. Market Value Method
The Market Value Method allocates revenue according to the current market value of each product.
Products having higher market values are assigned a larger proportion of total revenue.
Example
| Product | Market Value (₹) |
|---|---|
| A | 5,00,000 |
| B | 3,00,000 |
Revenue is apportioned in the ratio of 5:3.
Features
- Based on market value.
- Considers economic significance.
- Suitable for products with different prices.
- Helps determine profitability.
- Easy to understand.
- Affected by market fluctuations.
6. Constant Gross Margin Percentage Method
Under this method, revenue is apportioned so that all products earn the same gross profit percentage.
The method ensures uniform profitability across all products and is useful for managerial decision-making.
Example: If the desired gross profit margin is 25%, revenue is allocated to ensure each product earns the same percentage of profit.
Features
- Based on uniform gross profit.
- Useful for performance evaluation.
- Considers profitability.
- Helps in managerial decisions.
- Involves complex calculations.
- Requires detailed financial information.
7. Weighted Average Method
Under the Weighted Average Method, revenue is apportioned by assigning weights to products according to factors such as quantity, quality, or market importance.
Example
| Product | Weight |
|---|---|
| A | 4 |
| B | 2 |
Revenue is allocated in the ratio of 4:2 or 2:1.
Features
- Based on assigned weights.
- Flexible and practical.
- Suitable for diverse products.
- Considers product importance.
- More realistic than simple quantity methods.
- Involves managerial judgment.
Illustration of Cost and Revenue Apportionment
Suppose a farm produces two products, Milk and Manure.
Total Common Cost = ₹1,50,000
| Product | Sales Value |
|---|---|
| Milk | ₹4,00,000 |
| Manure | ₹1,00,000 |
| Total | ₹5,00,000 |
Cost Allocation:
- Milk = ₹1,20,000
- Manure = ₹30,000
Profit:
| Product | Revenue | Cost | Profit |
|---|---|---|---|
| Milk | ₹4,00,000 | ₹1,20,000 | ₹2,80,000 |
| Manure | ₹1,00,000 | ₹30,000 | ₹70,000 |
