Joint and by product costing 4: The net realizable value method

This video introduces the net realizable value (NRV) method, the third approach for allocating joint costs in joint and byproduct costing. It revisits the fundamental concepts of joint and byproduct costing, delves into the specifics of the NRV method, presents a practical example, and discusses its pros and cons, as well as its suitability for different scenarios.

Joint and byproduct costing involves creating multiple products simultaneously from the same manufacturing process using raw materials, labor, and overheads. Before the split-off point, costs cannot be individually traced, necessitating various allocation methods for joint costs. After the split-off point, products are separately identifiable and may incur further processing costs that are directly traceable.

The net realizable value method allocates joint costs based on the net realizable value at the split-off point. Unlike the sales value at split-off point method, NRV works backward from the final selling price by subtracting further processing costs. This method is crucial when direct sales values at the split-off point are unavailable. It assumes that a higher net realizable value indicates higher incurred costs.

A practical example demonstrates the NRV method using 'Joint Co.' which produces three products with total joint costs of 400,000 rand (after adjusting for any byproduct realizable value). The process involves calculating each product's net realizable value by subtracting further processing costs from the final sales value, then using these NRV figures to allocate the total joint costs proportionately.

To calculate the net realizable value for each product, multiply the units produced by the final sales price to get the total final sales value, and then subtract the given further processing costs. These individual net realizable values are then used to determine the proportion of total joint costs (400,000 rand) allocated to each product, and subsequently the joint cost per unit.

The NRV method effectively addresses issues found in the physical measures method, allowing for mixed units of output and accurate inventory valuation. It also overcomes the limitation of needing a sales price at the split-off point, unlike the sales value at split-off method. However, it can result in differing gross profit percentages for products and assumes that further processing adds no additional sales value beyond its cost. The underlying assumption linking NRV to cost can also be questionable.

The net realizable value method is most appropriate when there is no observable sales value at the split-off point, when a direct correlation between net realizable value and cost is logical, and especially when further processing contributes minimally to the product's final sales value. The video concludes by preparing for the next topic: the constant gross profit percentage method.