Accounting Implications of Byproduct Processing

A byproduct can be defined as a secondary product made during the manufacture of another product. The original product is often called the main product. Byproducts are also defined as being "the products of a joint production process that have low total sales value when compared with the total sales value of the main product or of joint products" (Horngren et al, 2006, p. 567). Examples of byproducts include orange oil collected from the peels of processed oranges, molasses produced during the process of refining sugar, and asphalt created from the process of refining crude oil (Wikimedia Foundation, Inc., 2006).

Advantages of Byproduct Processing

There are several advantages to byproduct processing. One advantage is that it converts waste into a product that can be sold. This can result in increased profit by greatly reducing waste and increasing revenue. Byproduct processing may also be good for the environment due to the conversion of scrap into a useable product. In addition, any costs associated with disposal of the waste are eliminated when that waste is converted into the byproduct.

Disadvantages of Byproduct Processing

One disadvantage of byproduct processing is the potential for increased cost. This is because the byproduct will most likely require additional processing after it has been removed from the main product. Additionally, byproduct processing "can affect the allocation of joint costs" (Horngren et al, 2006, p. 577). However, "by-product cost is commonly regarded as difficult to determine" (Slater & Wootten, n.d.).

Byproduct Accounting Methods

There are two chief methods of accounting for byproducts. These methods are the sales method and the production method. The sales method recognizes the byproduct in the income statement at the time of sale. This method is most commonly used in practice due to its simplicity. The production method "recognizes the byproduct in the financial statements...in the month it is produced" (Horngren et al, 2006, p. 578). This method allocates costs using the net realizable value method and offsets the costs against the costs of the main product. The production method is the preferred method because it complies with the GAAP matching principle by matching "the revenues and expenses from selling the main product" (Horngren et al, 2006, p. 580).

Conclusion

Companies that are considering implementing byproduct processing should first compare the advantages and disadvantages associated with using the product waste to manufacture a new, additional product. A cost-benefit analysis evaluating the additional costs versus potential increased revenue would also be helpful in making this decision.

References

Horngren, C. T., Datar, S. M., & Foster, G. (2006). "Cost Accounting: A managerial emphasis." (12^th ed.). Upper Saddle River, NJ: Pearson Prentice Hall.

Slater, K. & Wootten, C. (n.d.) "Monograph on joint and by-products costing." All India Cost and management Accountants Society website. URL: http://www.aicmas.com/bp.doc.

Wikimedia Foundation, Inc. (2006). "By-product." Wikipedia website. URL: http://en.wikipedia.org/wiki/Byproduct.