Meaning of By-Products
In a manufacturing process, a main product is accompanied by production of one or more by-products. In other words by-product is a residual material, which is recovered incidentally from the production of a major product. Moreover, by-product has small sales value compared with the main product.
Definition of By-Products
Kohler definers a by-product as
a secondary product obtained during the course of manufacture, having a relatively small importance as compared with that of the chief product or products.
Jain and Narang define a by-product as
Saleable or usable value incidentally produced in addition to the main product.
According to CIMA Terminology, By-product is
a product which is recovered incidentally from the material used in the manufacture of recognized main products such as having either net realizable value or a usable value which is relatively low in comparison with saleable value of the main products. By-products may further be processed to increase their realizable value”.
Thus, the term by product is used to denote the one or more products produced relatively in small value and produced along with the main product, which has greater value. Sometimes, by-products are used within the factory itself instead of buying a different material from outside. Besides, by-products have not only realizable value but also have usable value.
Classification of By-Products
The by-products have been classified into two groups. This classification is made according to the marketable condition at the split off point.
1. Sold as it is originally produced.
2. Sold only after undergoing further processing.
Differences between By-Products, Main Products and Joint Products
A product may be determined either as a by-product or a joint product or a main product by applying two checks. They are briefly explained below.
If any one of the products has more value than other products, which are incidentally, produced from the same type of raw material that product is to be considered as main product.
Likewise, if a product has less value than other products that product is to be considered as by-product. Sometimes, all the products have more or less equal value and produced from the same type of raw material. If so, they are considered as joint products.
2. Manufacturing Objective
If the company has the objective of producing only one product, the specified product is considered as main product. All other products are treated as by products. Likewise, if a company has the objective of producing two or more products from the same type of raw material, all the products are considered as joint products.
Accounting of By-Products
The accounting treatment of by-products may be classified into two categories. They are non-cost methods or sales methods and cost methods. These methods are briefly explained below.
I. Non-Cost or Sales Methods of Accounting By-Products
1. Other Income or Miscellaneous Income Method
Under miscellaneous method, the sales value of by-product is recorded in the credit side of the costing profit and loss account as it is treated as other income or miscellaneous income. If the by-product is not sold, the value of by-product is nil for balance sheet purpose. But, this is not correct method of valuation of closing stock. Moreover, the valuation of closing stock is not accurate.
The reason is that there is a time lag between the production and sales of a by-product. Sometimes, the by-products may arise in one accounting year but accounted for in the succeeding accounting year. This may distort the profits of two periods.
2. Sales of By Product added to the Main Product Sales
Under this method, the combined cost of main product and by-products are deducted from the combined sales of main product and by-products. There is no need of giving any weight age to the sale value of by-products. The value of closing stock of by-products is nil for balance sheet purpose.
3. Sales Value cf By product deducted from Total Cost
The Sales values of by-products are deducted either from production cost or from the cost of sales. Hence, the cost of main product is fluctuated on the basis of the fluctuating sales values of by-products. This leads to the inefficiencies connected with the production of main product. The closing stock of byproduct is valued at total cost or cost of sales basis.
4. Credit of By-product value less Selling and Distribution Costs:
The costs incurred for selling and distribution of byproducts are deducted from the sales value of by-products. The net amount is either deducted from the total cost or credited to process account. The closing stock of byproducts is valued at selling price less estimated costs likely to be incurred in the selling of by-products.
5. Credit of By-product Value less Selling and Distribution Costs and Costs incurred on By-product after Split Off Point
Under this method, both selling and distribution costs and processing costs after the point of separation are deducted from the sale value of the by-products and net amount is credited to the process account. The by-product is valued for the purpose of balance sheet at the selling price less estimated costs of selling and distribution and further processing of such by-products.
This method suffers from one disadvantage i.e., if the sale value of by-product fluctuates to that extent the credit to the Process Account of the main product will fluctuate accordingly. Moreover, such fluctuation may conceal the inefficiencies in that process.
6. Reverse Cost Method
Under this method, all the selling and distribution expenses, further processing costs after the split off point along with estimated profit are deducted from the sales value of by-products and the net amount is credited to the main product.
II. Cost Methods of Accounting By-Products
1. Opportunity (or Replacement) Cost Method
Under this method, the by-products are used as raw materials and consumed in the same undertaking for some other process. If the same materials (by-products) were purchased from the open market, the company would incur certain expenditure. Such expenditure is treated as opportunity or replacement cost. In the process account, where the by-product is emerged, the market value of such by-product (used as raw materials) is credited for the purpose of ascertaining the cost of main product.
2. Standard Cost Method
A standard cost may be fixed for each product by averaging the cost figures of the previous periods and the process account credited with this standard value.
3. Apportionment on Suitable Basis
This method is followed if the byproduct has the considerable value. The actual cost of by-product should be ascertained by apportioning the joint costs up to the point of separation. This method is followed under two situations. The by-products are processed to dispose of waste materials more profitably and to utilize the idle plant profitably.