By-products are secondary outputs stemming from a production process, accompanying main products but holding minimal sales value. Unlike joint products, which substantially contribute to revenue, by-products are typically sold at lower prices or in limited quantities, exerting only a marginal impact on overall sales. The economic distinction lies in their significance, with joint products playing a pivotal role in revenue generation, while by-products are considered ancillary outputs. Cost accounting recognizes this difference, employing specialized approaches due to varying sales values.
By-product
In the world of process costing, a by-product refers to a secondary output that accompanies the main product during production. While by-products are a natural outcome of manufacturing, they hold minimal sales value compared to the primary goods. Unlike joint products, which are significant contributors to a company’s revenue, these secondary outputs are considered ancillary and exert a negligible impact on overall sales. This distinction plays a crucial role in cost accounting, where specialized approaches are employed to handle these outputs effectively.
What Is a By-Product?
A by-product is an additional outcome of the manufacturing process that occurs alongside the main outputs. Unlike joint products—which hold substantial market value and are vital to a company’s profitability—by-products are typically sold at lower prices or in smaller quantities. Their role in the production process is secondary, often perceived as an unintended but manageable result.
Key Characteristics:
- Minimal Sales Value: These outputs have a lower market value compared to the primary outputs.
- Secondary Role: They are not central to the company’s revenue generation strategy.
- Common in Production: These secondary outputs are especially prevalent in industries like petroleum refining, food processing, and chemical manufacturing.
They may not be the star of the show, but their efficient management can significantly contribute to operational sustainability and cost optimization.
By-Product vs. Joint Product: What’s the Difference?
The fundamental difference between these two items lies in their economic significance:
- Joint Products: These are primary outputs from the same production process, each holding substantial sales value and contributing significantly to revenue.
- By-Products: These are secondary outputs with minimal economic impact, often treated as supplementary.
For example, in the petroleum industry, gasoline, diesel, and jet fuel are joint outputs, while asphalt and lubricants are secondary outputs that are sold at lower prices.
Accounting for By-Products
Managing these secondary outputs effectively requires tailored accounting approaches to ensure accurate financial reporting. Two primary methods are commonly used:
1. Adding By-Product Income to Sales
This straightforward approach treats the income from these outputs as supplementary and includes it in the sales section of the income statement. It’s suitable for situations where the economic impact of these secondary outputs is negligible.
2. Deducting By-Product Sales Value from Processing Costs
In this method, the sales value of the secondary output is subtracted from the total processing costs before allocating expenses among the joint outputs. This approach provides a more accurate reflection of the costs associated with producing the primary goods.
Real-World Example
Let’s revisit the petroleum industry to understand these outputs in action:
- Primary Outputs: Gasoline, diesel, and jet fuel are the main outputs driving revenue.
- Secondary Outputs: Asphalt and lubricants, produced during the refining process, hold lower market value but are still sold to maximize overall efficiency.
Efficient management of these secondary outputs ensures not only cost optimization but also environmental sustainability by minimizing waste.
The Importance of Managing By-Products
While these secondary outputs may appear insignificant, its management is crucial for several reasons:
- Operational Efficiency: Effective utilization of By-products reduces waste and improves production efficiency.
- Cost Optimization: Proper accounting ensures accurate allocation of costs, enhancing profitability.
- Sustainability: These secondary outputs can often be repurposed or sold, contributing to environmentally friendly practices.
Conclusion
Understanding and managing these secondary outputs is an essential aspect of process costing. These outputs, while economically less significant than joint products, play a vital role in enhancing operational efficiency and sustainability. By employing tailored accounting approaches and leveraging industry-specific strategies, businesses can maximize the value derived from by-products and achieve more accurate financial reporting.
Key takeaways
- Definition of By-Product: A secondary output of production with minimal sales value compared to joint outputs.
- Difference from Joint Products: Joint outputs are primary revenue drivers, while these secondary outputs are ancillary.
- Accounting Approaches: Two main methods—adding income to sales or deducting its value from processing costs.
- Significance: Proper management of secondary outputs contributes to cost efficiency and sustainability.
Further Reading:
Process Costing
Joint Products
Cost Centre Performance Measurement
Process costing – joint products