Joint Products and By-Products: Allocating Cost When One Process Yields Many

In many manufacturing and processing operations, one input flow yields multiple outputs at the same time — crude oil into petrol, diesel, kerosene; milk into cream, skim, whey; even sheet steel into a finished part and off-cuts. Costing each output requires splitting the joint cost of the shared process. Here is how it works and why the method matters.

Joint products vs by-products

A first distinction:

• Joint products are two or more outputs of comparable value that emerge from the same process. None of them is incidental — they are all reasons the process exists.
• By-products are outputs of relatively minor value that emerge alongside a primary product. They are not the reason the process exists; they happen anyway.

The distinction is one of materiality — there is no formal rule. If an output represents less than ~10% of total sales value, it is typically treated as a by-product. Above that, it is a joint product.

The accounting treatment is different for each.

The split-off point

The shared cost of producing the joint outputs is incurred before the split-off point — the point at which the products become physically separable. After split-off, each product may need further processing (refining, packaging) which is identifiable and assigned only to that product.

The question is how to allocate the shared cost up to the split-off point across the products that emerged.

Three allocation methods for joint products

1. Physical units method. Allocate joint cost in proportion to the physical quantity of each product produced.

Simple — but only fair when the products have similar value per unit. A cutting operation that yields finished parts and steel off-cuts in equal weight would over-allocate to the off-cuts using physical units, because off-cuts are worth far less per kg.

2. Sales value at split-off. Allocate in proportion to the sales value of each product at the point of split-off.

This is the most common method because it links cost allocation to revenue potential. A product worth ten times more carries ten times more of the joint cost. Reasonable.

Limitation: requires a clear market price at split-off, which may not exist for intermediates that need further processing.

3. Net Realisable Value (NRV) method. Allocate in proportion to NRV — the final selling price of each product minus the cost of further processing after split-off.

Use this when you have no market price at split-off but you do have a final sales value and you know the further-processing cost. Works for most real situations.

A worked example

A small dairy processes 1,000 litres of milk into 100 litres of cream and 900 litres of skim. Joint processing cost is ₹10,000.

• Cream sells for ₹100/litre = ₹10,000 revenue
• Skim sells for ₹20/litre = ₹18,000 revenue

Physical units method: Cream gets 100/1,000 = 10% → ₹1,000. Skim gets 90% → ₹9,000.

Sales value method: Total ₹28,000. Cream is 10,000/28,000 = 35.7% → ₹3,571. Skim is 64.3% → ₹6,429.

Big difference. The physical method makes cream look extremely profitable (cost ₹1,000, sells ₹10,000) and skim look terrible (cost ₹9,000, sells ₹18,000 — ₹9,000 margin on ₹9,000 cost). The sales value method gives a more balanced view.

By-product accounting

By-products are typically treated more simply because the values involved are small. Common approaches:

• Net the by-product income against joint cost. Revenue from the by-product (less any further processing) reduces the joint cost allocated to the main products.
• Recognise as miscellaneous income. The by-product's net realisation goes straight to "other income" on the P&L. Main products carry the full joint cost.

Either works; pick one and apply it consistently. The first is more accurate; the second is simpler and often used for genuinely minor by-products.

Why allocation method matters

The allocation method does not change total profit — that is determined by total revenue minus total cost regardless of how the cost is split. What it changes is the apparent profitability of each product.

That apparent profitability drives:

• Pricing decisions — products that look unprofitable get price increases
• Product-mix decisions — products that look unprofitable get de-prioritised
• Discontinuation decisions — products that "lose money" get cut

A bad allocation can lead to cutting the very products that subsidise the rest — which collapses the whole picture.

Joint costs are irrelevant for sell-or-process-further decisions

A useful insight: when deciding whether to process a joint product further or sell it at split-off, the joint cost is irrelevant. It is sunk by then. The only question is whether the incremental revenue from further processing exceeds the incremental cost of doing the further processing.

This is one of the more common make-or-buy-style decisions in process industries, and getting it wrong typically traces back to including allocated joint cost where it does not belong.

How Booksmor helps

Booksmor supports multi-output BOMs — a single production run that yields a finished good plus a by-product or co-product, with the allocation method (physical units, sales value, NRV) set per recipe. Joint cost gets split per the method automatically, with a clean view of how each output's cost was built up. Start a 30-day free trial and cost multi-output processes correctly.