Relative Market Value methods (Sales Value at Split off method and Net Realizable value method)

Relative Market Value Methods are used in cost accounting to allocate joint costs among products that are produced from a common process, especially in industries like oil refining, chemical production, and agriculture where several products are derived from a single process. The Sales Value at Split-off Method and the Net Realizable Value (NRV) Method are the two commonly used methods under this approach.

Sales Value at Split-off Method

Sales Value at Split-off Method allocates joint costs based on the proportion of the sales value of each product at the split-off point. The split-off point is the stage in the production process where joint products become separately identifiable.

This method assumes that the market values at the split-off point provide a fair basis for cost allocation, and products with higher sales values are allocated more costs.

Key Features:

• Joint costs are allocated according to each product’s relative sales value at the point where they become separable.
• The method is easy to apply when there are market prices for the products at the split-off point.
• It assumes that all joint products are equally marketable without further processing.

Steps to Apply the Sales Value at Split-off Method:

1. Determine Sales Value at Split-off Point:

Identify the sales price for each product at the split-off point and calculate the total sales value for each product.

2. Calculate Total Sales Value:

Add up the total sales value of all the joint products.

3. Allocate Joint Costs:

Allocate joint costs to each product based on the ratio of its sales value at split-off to the total sales value.

Joint Cost Allocation = [Sales Value of Product at Split-off / Total Sales Value at Split-off ] × Total Joint Costs

Example: Suppose a company produces three joint products, A, B, and C, with the following information:

The total joint costs amount to $15,000. The allocation of joint costs is done as follows:

• Product A: [10,000 / 20,000] × 15,000 = 7,500
• Product B: [6,000 / 20,000] × 15,000 = 4,500
• Product C: [4,000 / 20,000] × 15,000 = 3,000

Thus, joint costs are allocated as $7,500 to Product A, $4,500 to Product B, and $3,000 to Product C.

Advantages:

• Simple and straightforward if market prices at split-off are available.
• Reflects the economic value of each product at the split-off point.

Disadvantages:

• Relies heavily on the assumption that products can be sold at the split-off point.
• If there are no market values at split-off, the method cannot be applied.
• Does not account for further processing costs, which may be necessary to make the products marketable.

Net Realizable Value (NRV) Method

Net Realizable Value (NRV) Method is used when joint products require further processing after the split-off point before they can be sold. It allocates joint costs based on the Net Realizable Value of each product, which is the final sales value minus any additional processing costs required after the split-off point.

Key Features:

• Allocates joint costs according to the final sales value (after further processing) minus the cost of further processing.
• Suitable when the products require further processing after the split-off point to be sold.
• The method reflects the profitability of each product after considering additional costs incurred to make the product marketable.

Steps to Apply the NRV Method:

1. Determine Final Sales Value:

Identify the final sales value of each product after any further processing.

2. Calculate Net Realizable Value (NRV):

Subtract the further processing costs from the final sales value to get the NRV for each product:

NRV = Final Sales Value − Further Processing Costs

3. Calculate Total NRV:

Add up the NRV of all joint products.

4. Allocate Joint Costs:

Allocate joint costs based on the ratio of each product’s NRV to the total NRV.

Joint Cost Allocation = [NRV of Product / Total NRV] × Total Joint Costs

Example: Let’s say there are three joint products, X, Y, and Z, with the following information:

The total joint costs amount to $18,000. The allocation of joint costs is done as follows:

• Product X: [12,000 / 24,000] × 18,000 = 9,000
• Product Y: [8,000 / 24,000] × 18,000 = 6,000
• Product Z: [4,000 / 24,000] × 18,000 = 3,000

Thus, joint costs are allocated as $9,000 to Product X, $6,000 to Product Y, and $3,000 to Product Z.

Advantages:

• Reflects the economic reality by considering the additional processing required to sell the products.
• Useful when joint products require further work after the split-off point.
• Helps assess the profitability of products after accounting for additional processing costs.

Disadvantages:

• Requires accurate estimates of further processing costs, which can sometimes be difficult to determine.
• Complex to apply if multiple products require varying degrees of further processing.
• Does not consider the sales value at split-off if that information is more relevant to certain business contexts.

Comparison of the Two Methods