The split-off point is the stage in a joint production process at which two or more products become separately identifiable. Before that point, materials, labor and overhead are spent on all the products together and are known as joint costs. After it, each product can be sold as it is or processed further, and any additional costs are traced to that product alone.
Split-off points are common in petroleum refining, where crude oil yields gasoline, diesel and jet fuel; in meatpacking; in dairy processing, where raw milk separates into cream and skim milk; and in lumber and chemicals. The concept matters for two reasons. Joint costs must be allocated to the joint products at this point to value inventory, and the decision whether to sell or process further is made here. Products of small value that emerge at the same point are treated as a byproduct.
The split-off point in plain terms
Think of a butcher who buys a whole side of beef for one price. Until it is cut up, there is no way to say how much of that price belongs to the steaks and how much to the mince. The moment the carcass is cut into separate pieces is the split-off point.
From then on, each piece has its own future. The steaks may be sold straight away, while the trimmings might be turned into sausages, which takes extra work and extra cost. The butcher has to decide, piece by piece, whether that extra work is worth it, and also needs some fair way of sharing the original purchase price across all the cuts for the books.
Allocating joint costs at the split-off point
Four allocation methods are commonly used:
- Physical units method. Joint costs are shared in proportion to a physical measure such as gallons, pounds or barrels.
- Sales value at split-off method. Joint costs are shared in proportion to each product's market value at the split-off point.
- Net realizable value method. Where a product has no market at split-off, its final sales value minus further processing costs, its net realizable value, is used as the weighting.
- Constant gross margin method. Joint costs are allocated so that every product earns the same gross margin percentage overall.
A dairy spends $60,000 processing raw milk, which yields 2,000 gallons of cream that sells at split-off for $30 a gallon ($60,000) and 8,000 gallons of skim milk that sells for $5 a gallon ($40,000). Under the sales value method, cream takes 60 percent of the joint cost, $36,000, and skim milk 40 percent, $24,000. Under the physical units method, cream takes 20 percent, $12,000, and skim milk 80 percent, $48,000. The method chosen changes each product's reported profit.
Sell or process further
Joint costs are already spent by the split-off point, so they are a sunk cost for any later decision. The only relevant costs are those that differ between alternatives. In the dairy example, the cream could instead be churned into butter that sells for $95,000, at an extra processing cost of $28,000. The incremental revenue is $35,000 ($95,000 minus $60,000) and the incremental cost is $28,000, so processing further adds $7,000 of profit. The allocated $36,000 of joint cost plays no part in this calculation.
Byproducts and multiple split-off points
Byproducts are usually recorded in one of two ways: their net realizable value is deducted from the joint cost of the main products, or the proceeds are reported as other income when the byproduct is sold. Some processes have more than one split-off point. A refinery may separate crude oil into several streams and then split one of those streams again further down the line, so joint costs are allocated in stages. These calculations sit within cost accounting and, in mass production, within a process costing system.
Limitations
Any allocation of joint cost is to some extent arbitrary, because no single product causes the joint cost on its own. Allocated figures are needed for inventory valuation and external reporting, but they can mislead managers. A product that looks unprofitable after allocation may still contribute to covering joint costs, and dropping it would not save any of those costs. For this reason, management decisions are made on incremental figures, not on allocated product profits.