What is by product in process costing?

Understanding By-Products in Process Costing: More Than Just Scrap

Process costing, a crucial method for valuing inventory in industries with mass production, often yields more than just the intended primary product. These additional outputs, known as by-products, represent a distinct accounting challenge. Unlike joint products, which share significant value and require complex allocation of production costs, by-products have a comparatively low value and sales volume. Their existence subtly complicates the already intricate process of cost allocation.

The key distinction between a by-product and a joint product lies in their relative market value. While joint products (e.g., gasoline, kerosene, and lubricating oil from crude oil refining) are all considered significant and valuable outputs deserving of meticulous cost allocation, by-products are secondary outputs with minimal economic importance in relation to the main product. Think of the sawdust generated during lumber production, or the whey leftover from cheesemaking. These are by-products; their value is significantly less than the primary product’s (lumber and cheese, respectively).

The low value of by-products necessitates a simplified accounting treatment. The common approach involves recognizing by-product revenue after deducting the cost of separating and preparing them for sale. This differs markedly from the complex cost allocation required for joint products, which involves techniques like the physical-measure method or the sales-value-at-split-off method.

For by-products, the net realizable value (NRV) – the selling price less any further processing and selling costs – is often used. This NRV is then typically credited to the cost of goods sold of the main product, effectively reducing the overall cost of production. This is because the revenue generated from the by-product helps offset some of the expenses incurred during the manufacturing process. This method simplifies accounting, avoiding the complexities of allocating joint production costs to low-value outputs.

However, the line between by-product and joint product can sometimes blur. A by-product in one scenario might be considered a joint product in another, depending on market conditions and technological advancements. For instance, what was once considered a low-value byproduct might gain significant market value due to innovations in processing or changes in consumer demand, necessitating a recalculation of its accounting treatment.

In conclusion, while seemingly insignificant, by-products require careful consideration in process costing. Understanding their distinct characteristics and applying the appropriate accounting method – focusing on net realizable value and its impact on the primary product’s cost – ensures accurate financial reporting in industries where multiple outputs result from a single manufacturing process. The simplification afforded by focusing on NRV allows for a more efficient and accurate reflection of the overall profitability of the manufacturing operation.