Production Method vs. the Sales Method - Method of Costing, Cost Accounting Video Lecture | Cost Accounting - B Com

in this video we're gonna talk about how
to account for byproducts so let's say
that you start a mining operation and it
costs you $300,000 to mine some gold and
there's a separation process involved
because as your mining the gold you get
rocks and pebbles different things that
you have to weed out to get to the gold
and that cost $200,000 to do that
process and then ultimately your product
is that you get some gold and let's just
say that the sales value of that gold is
$800,000 but in addition to that gold
you get some fool's gold right and then
let's say that fool's gold is worthless
but you have this friend of yours who
collects fool's gold and so you can sell
this fool's gold as much as you get to
your friend now your friend doesn't have
a lot of money so the sales value that
fool's gold is just $6,000 but hey
you'll take the $6,000 right so if we
add up the sales values here we have a
total of eight hundred and six thousand
dollars almost all of which is
attributable to the gold right so in
this case we would call the fool's gold
a byproduct right we've been talking in
the past about joint products and
allocating the joint costs to the joint
products but when we have some a product
where the sales value is so low relative
to all the other products we sometimes
just call it a byproduct and just say
that it's not really material right it's
not a huge thing that we really need to
do a lot of accounting for so we have a
really simple way of doing it and
actually there are a couple different
ways that we can account for this
by-product so the one way is called the
production method so under the
production method what we're gonna do is
we're gonna recognize that by-product in
the period in which it's produced right
so when we mined the gold and we get
that fool's gold we're gonna recognize
that by-product the fool's gold at its
net realizable value I'm just gonna
abbreviate that NRV the net realizable
value of the fool's gold right so that's
the selling price less than a cost to
complete the transaction let's just
assume in this case that the net
realizable value is the same as the
sales value of 6
thousand dollars you've got the fools
gold your friend comes by and buys it
there's no additional cost right so
what's gonna happen is this this $6,000
in fool's gold is going to reduce it's
gonna reduce your cost right you've got
500,000 and cost that you incur to to
produce the gold well one thing you
could do is you could reduce your cost
of goods sold for the gold right so when
you go and you actually sell the gold
right let's say you sold all the gold so
you're gonna debit cost of goods sold
and you're going to credit inventory
well you can just debit the cost of
goods sold for instead of five hundred
thousand is five hundred thousand less
the six thousand dollars of the
byproducts that would be four hundred
ninety four thousand dollars right so
you've you've reduced your cost of goods
sold another way of doing it is you
could actually put the sales of the
byproduct they could ultimately go and
this now we're getting into the sales
method right so another another method
is that we can basically recognize this
this by-product when we sell the fool's
gold itself right here we're recognizing
it when we produce the gold when we mine
the gold we immediately recognize that
by-product that it's NRV but we could
also wait till we actually sell to will
actually sell it so at that point that
was basically a question of timing
really right timing is the the key
difference between these two methods
right which is gonna come into play in
terms of earnings management right
because a manager if you get a bunch of
these brought by products built up in
inventory the manager could wait till
it's a bad period where earnings are low
and then sell some of that by-product to
boost profitability so that's something
to be wary of but basically what you
could do is you could sell this and it
recognized that when sold right
recognized by product when sold and it
could also go to something like instead
of reducing your cost of goods sold it
could go to something like other sales
or you might see it in other income
sometimes you see something on it in
cups it misses other income and you're
wondering what is in this account well
it might be that they're worse
by products that were sold