Joint and by product costing 5: The constant gross profit percentage method

This video introduces the constant gross profit percentage method for allocating joint costs, the final method in the series. It will cover the basic idea, a practical example, its advantages, disadvantages, and suitability.

A joint process involves taking raw materials, labor, and overheads to produce multiple products simultaneously. Products are indistinguishable until the split-off point, after which further processing costs can be traced to individual products.

Unlike the net realizable value method, which results in different gross profit percentages, the constant gross profit percentage method assumes all products from the same process should have an identical gross profit percentage, reflecting an equal relationship between sales value and costs for each product.

The video uses an example of a company producing three products with total joint costs of R400,000. It emphasizes adjusting joint costs for any by-products, scrap, or waste before allocation. Details at the split-off point, further processing costs, and final sales values are provided. The sales value at split-off point is ignored for this method.

The first step is to calculate the joint process's combined gross profit percentage. This involves finding the combined sales value by multiplying each product's units by its final sales price, and then deducting all processing costs (joint costs and further processing costs) to arrive at the combined gross profit. For this example, the combined gross profit percentage is 25.15%.

To allocate joint costs, the video calculates each product's total cost using the formula: Total Cost = Sales Value - Gross Profit. The total sales value for each product is determined, and the gross profit is calculated by multiplying the sales value by the 25.15% gross profit percentage.

The total cost of sales for each product is known, and further processing costs are given. By subtracting the further processing costs from the total cost of sales, the joint costs allocated to each product are determined. The total allocated joint costs sum up to the initial R400,000.

This method addresses problems of physical measures and the sales value at split-off method by not requiring sales value at split-off and allowing different measurement units. It also ensures a consistent gross profit percentage for all products. However, its main disadvantage is the questionable assumption that all products should have the same gross profit percentage. It is suitable when split-off sales value is unavailable and the constant gross profit percentage assumption is logical.