Byproduct Accounting

A manufacturing process will nearly always result in an unintended ancillary byproduct being produced. These byproducts may be regarded as waste and have zero value or might be useful products in themselves, but having a minimal value relative to the main or joint products generated by the process.

Since the accounting impact of the byproduct is minimal the question arises as to how to account for any value the product has and any disposal value generated when the product is sold.

Methods of Accounting for a Byproduct

There are two methods of accounting for a byproduct known as the production method and the sales method. The production method recognizes the value of the by-product when it is produced, and the sales method recognizes the value when the by-product is sold.

Production Method of Accounting

The production method of accounting for byproducts has the following features.

  1. The byproduct is recognized in the accounting period in which it is produced.
  2. Production costs equal to the net realizable value (NRV) of the byproduct are allocated to the byproduct. The effect of this allocation is to reduce the net production cost of the main product.
  3. The byproduct is included as part of the inventory of the business.
  4. When the byproduct is sold, since its sales value and cost are both equal to the NRV, the profit on the sale is zero.

Sales Method of Accounting

The sales method of accounting for byproducts has the following features.

  1. The byproduct is only recognized in the accounting period in which it is sold.
  2. Production costs are not allocated to the byproduct.
  3. The byproduct is not held as inventory.
  4. The net realized value (sales value) of the byproduct when it is sold is included in the revenue or sundry income of the business.
  5. Since the costs allocated to the byproduct are zero, the profit on disposal is equal to the sales value.

Byproduct Accounting Example

Suppose a business operates a manufacturing process which shows total production costs for the accounting period of 8,400. The process produces a main product which sells for 12.00 a unit, but also produces a waste by-product which the business can sell for 0.50 a unit.

The number of units of the main product and by-product produced and sold during the accounting period are shown in the table below.

Units
Main product By-product
Beginning inventory 0 0
Production 1,500 300
Sales 800 200
Ending inventory 700 100

Income Statements

By applying the two methods described above, the following comparative income statements can be produced.

Income Statements
Production method Sales method
Main 9,600 9,600
Byproduct 100
Revenue 9,600 9,700
Production costs 8,400 8,400
Byproduct NRV -150
Net cost 8,250 8,400
Unit cost 5.50 5.60
Ending inventory -3,850 -3,920
COGS 4,400 4,480
Gross margin 5,200 5,220
Gross margin % 54.17% 53.81%

Income Statement Notes and Explanations

The revenue from the main product is the same in both cases

Main revenue = Units sold x price
Main revenue = 800 x 12.00 = 9,600

Production Method

1. Using the production method, the byproduct net realizable value (NRV) is calculated at the time of production as follows.

Byproduct NRV = Units produced x price
Byproduct NRV = 300 x 0.50 = 150

2. Production costs equal to this amount (150) are allocated to the byproduct inventory, this reduces the production costs for the main product to a net amount of 8,250. The unit price of the main product is calculated as follows.

Unit price = Production cost / Units produced
Unit price = 8,250 / 1,500 = 5.50 

3. The ending inventory of the main product is calculated as follows.

Ending inventory = Unit cost x ending units
Ending inventory = 5.50 x 700 = 3,850

4. It should be noted that there is also remaining inventory of the byproduct, under the production method this is not recognized in the income statement.

The inventory is calculated as follows.

Ending inventory = Unit NRV x ending units
Ending inventory = 0.50 x 100 = 50

Sales Method

1. Using the sales method the byproduct value is calculated and included in revenue when the by-product is sold.

In this accounting period the revenue from the byproduct is calculated as follows.

Revenue = Units sold x price
Revenue = 200 x 0.50 = 100

2. The total costs of production are allocated to the main product resulting in a unit price calculated as follows.

Unit price = Production cost / Units produced
Unit price = 8,400 / 1,500 = 5.60

3. The ending inventory of the main product is calculated as follows.

Ending inventory = Unit cost x ending units
Ending inventory = 5.60 x 700 = 3,920

Byproduct Accounting Journals

The double entry bookkeeping journals used to post the transactions relating to byproducts are shown below for each of the two methods.

Production Method Journals

Production method: By-product produced
Account Debit Credit
Inventory 150
Production cost 150
Total 150 150

The production cost is reduced by the NRV of the byproducts which is added to the by-product inventory.

Production method: By-products are sold
Account Debit Credit
Accounts receivable 100
Inventory 100
Total 100 100

When 200 units of the by-product are sold the inventory is reduced by the sales value (200 x 0.50 = 100), and an accounts receivable is established representing an amount due from the customer.

It should be noted that as the total NRV has already been reflected in the income statement when the by-product was produced, the sale is dealt with as a balance sheet transaction .

The balance of the by-product units (100) remain in inventory until sold in the future.

Sales Method Journals

Sales method: By-products are sold
Account Debit Credit
Accounts receivable 100
Revenue 100
Total 100 100

Using the sales method, when the 200 units are sold, the value is included as part of the revenue of the business, and again an account receivable is established.

The remaining units are not reflected in the inventory of the business and will only be recognized when sold at some future date.

By-products and GAAP

The by-product production and sales methods both fail to comply with GAAP as production costs are not properly allocated to the by-product. The proper method would be to treat the by-product equally with the main products from the process i.e as a joint product. Due to the minimal value of the by-product, an analysis would show that the costs of complying with GAAP would far outweigh the benefits of doing so.

Byproduct Accounting July 5th, 2017Team

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