Name: Bhavinkumar Parmar, MAC-II

Roll No: 2010PGP084, Section A

Assignment on Lilac Flour Mills

About Lilac Flour Mills:

Lilac Flour Mills processes wheat to produce white flour, suji, wholemeal flour, and bran. In
term of physical proportions, the average yield from a ton of wheat is 60 percent for white
flour, 10 percent for suji, 10 percent for whole meal flour and 20 percent for bran.

The production process: Plant consisted of several floors and is divided into two parts: i)
cleaning section and ii) milling section. Wheat is fed through a bin in the ground floor, which
is passed through dust and chaff removal buckets and then through a triour equipment to
remove corn, round seeds,maize and stones from wheat. It is then washed, dried and stored
in a clean bin.

Cleaned wheat is then passed through an aspiration-cleaning meachine where it is brushed

and then it reaches double roller mill. Wheat corn is then passed through roller mills and
plantsifters successively until all flour was won. The bran that remained is collected by
means of bran separator. The end products wer passed thorough wooden channels to the
ground floor where they were collected and packed.

Inventory Accumulation: Lilac processed about 36 tons of wheat perday. Every ton of wheat
yielded about 0.2 tons of bran which comes to about 7.2 tons per day. Wheat bran was
primarily used as cattle feed by livestock breeding centers where as flour, suji, and
wholemeal flour were used by direct household consumers and industrial units.

Existing Joint Cost Allocation Method: An average unit cost for each product was arrived at by
dividing the total joint costs by the combined output of the four products. The reason behind this
was that in as much as all the four products were obtained by the same process. The cost of packing,
selling and distribution incurred after the sieving stage was identified with individual products and
treated as separable costs.

Selling prices Cost Prices Separable Costs

White flour Rs 2100 Rs 1850 Rs 78
Suji Rs 2480 Rs 1850 Rs 84
Wholemeal
flour Rs 2000 Rs 1850 Rs 34
Bran :Rs. 1140. Rs 1850 Rs 16
Problems identified from the case:

1. As on December 31, 1973, Lilac Flour Mills was carrying an inventory of 2000 tons of
bran, which was valued at Rs.37,32,000
2. This is because the purchase offers ranged from Rs.1000 to Rs.1350, which was far
lower than the total cost that was calculated by the followed accounting procedure.
3. In the current procedure, the Joint costs in the process are allocated based on the
physical quantities proportion of the output. Because of this, we are getting a total
cost of Rs.1866 per ton for bran.
4. Hence if they are selling bran at the market price at the purchase prices available in
the market, they will incur a loss of around Rs. 760 which is why they are not able to
sell it. Hence a lot of bran is still left as inventory.
Name: Bhavinkumar Parmar, MAC-II
Roll No: 2010PGP084, Section A

From the above points, it is evident that the problem is due to the allocation of the
joint costs based on physical distribution.

Range of possible Solutions: When there are two are more products that undergo the same
process at the same time in the course of conversion, the joint costs should be allocated to
each of the products based on some allocation basis.

The allocation basis can be of different types:

1. Physical Quantity method: This is the method currently followed by Lilac Flour mills.
This is not yielding the required results as we end up allocating high cost to bran and
so not able to sell it.
 The ratio of the products in physical quantity produced per each unit of
wheat is 6:1:1:2 in the order of white flour, suji, wholemeal flour and bran
respectively. Calculation of Average unit product cost(Input=900 tons)

Joint cost
allocated basis Joint Separable Total Sales
on physical cost Cost per Cost price Profit Total
Product Production quantity per ton ton per ton per ton per ton profit
While
Flour 540 999000 1850 78 1928 2100 172 92880
Suji 90 166500 1850 84 1934 2480 546 49140
Whole
meal Flour 90 166500 1850 34 1884 2000 116 10440
-
Bran 180 333000 1850 16 1866 1140 -726 130680
900 1665000 21780

Table I
 Allocating the joint costs in the same proportion, we can split the joint costs
among the different products based on this proportion. Adding separable
costs to the joint costs will give the total cost per each product.
 The selling price is assumed to be the market price for different product as of
now in the market. The selling price for bran is assumed to be Rs.1140 per
ton.
The profitabilities of different products based on this method are tabulated in table I

2. Sales Value Method:

 In sales value method, we use the sales value as the basis for allocation.
 Name: Bhavinkumar Parmar, MAC-II
Roll No: 2010PGP084, Section A

Joint cost Joint Total

Sales allocated cost Separable Cost Profit
Production price per Sales on basis of per Cost per per per Total
Product in tons ton Value sales value ton ton ton ton profit
While
Flour 540 2100 1134000 1083626 2007 78 2085 15 8254
Suji 90 2480 223200 213285 2370 84 2454 26 2355
Whole
meal Flour 90 2000 180000 172004 1911 34 1945 55 4936
Bran 180 1140 205200 196085 1089 16 1105 35 6235
900 1742400 1665000 21780
Table II

 We allocate the joint costs based on the proportion of the Sales value of the
four products
 The following table-II gives the profitability of different products when this
method is adopted:

3. Net Realization Value(NRV) method:

 In NRV method, we use (selling price – separable costs) as the allocation basis for the
different products

Separable Cost per ton

Joint cost allocated on
basis of sales value
Net Realizable Value
Sales price per ton
Production in tons

at Split of Point

Total Cost per ton

Joint cost per ton
Separable Cost

Separable Cost

Proft per ton

per ton
Sales Value

Total proft
Product

While Flour 540 2100 1134000 78 42120 1091880 1077781 1996 78 2074 26 14099
Suji 90 2480 223200 84 7560 215640 212856 2365 84 2449 31 2784
Whole meal
Flour 90 2000 180000 34 3060 176940 174655 1941 34 1975 25 2285
Bran 180 1140 205200 16 2880 202320 199708 1109 16 1125 15 2612
900 1742400 1686780 1665000 21780
Table III

 Table III gives the allocation of the joint costs based on this method, and also
the profitability of the different products when this method is followed

4. Assuming all the three products other than white flour as by-products:
 In this case, we assume only white flour as the main product as it constitutes
60% of the total output. The remaining three products namely suji,
wholemean flour and bran are treated as by-products.
Name: Bhavinkumar Parmar, MAC-II
Roll No: 2010PGP084, Section A

Table IV

Joint cost
Sales allocated on Joint Total
price basis of cost Separable Cost Profit
Production per Sales assuming 3 per Cost per per per Total
Product in tons ton Value by-products ton ton ton ton profit
While Flour 540 2100 1134000 1070100 1982 78 2060 40 21780
Suji 90 2480 223200 215640 2396 84 2480 0 0
Wholemeal
Flour 90 2000 180000 176940 1966 34 2000 0 0
Bran 180 1140 205200 202320 1124 16 1140 0 0
900 1742400 1665000 21780
Table: IV
 When some of the products are treated as by-products, we presume that the
total cost of the by-product is just equal to the selling price of it. Or in other
words, profit for these products is zero.
 Hence, when we allocate the joint costs to the different products, we see that
the allot the joint costs to the by-products such that the total cost of these
equal their selling price. The remaining costs are allocated to the main
product which is the white flour.
 The tabe IV gives the cost allocation and the profitability for the different
products when this method is used

5. Assuming only Bran as by-product:

 Here, we assume only Bran as by-product. The other three products namely
white flour, suji and wholemeal flour are considered as main products
 Hence, we allocate the joint costs to Bran such that the total cost of Bran
equals its selling price.
 The remaining joint costs are allocated to the three main products based on
their sales value.
 Table V gives the cost allocation and profitability calculation for the different
products based on this method:

Joint cost
allocated
Sales on basis Joint Total
price of bran as cost Separable Cost Profit
Production per Sales a by per Cost per per per Total
Product in tons ton Value product ton ton ton ton profit
While Flour 540 2100 1134000 1079026 1998 78 2076 24 12854
Suji 90 2480 223200 212380 2360 84 2444 36 3260
Wholemeal
Flour 90 2000 180000 171274 1903 34 1937 63 56666
Bran 180 1140 205200 202320 1124 16 1140 0 0
 Name: Bhavinkumar Parmar, MAC-II
Roll No: 2010PGP084, Section A

900 1742400 1665000 21780

Table: V

6. Constant Gross margin NRV method:

 In this method, we calculate the total Gross margin on all the products
together, and we assume the same gross margin for different products

Evaluating the solutions:

Table VI gives the summary of all the alternatives discussed above and the gross margins
calculated for different methods:

1. Physical Quantity method:

From the case, it is clear that this method does not give the results that we expect.
We end up allotting a very high cost for Bran. So, this is not the appropriate method

Production Sales Net Realization assuming 3 Assuming Bran

Value Method Value Method Value by-products as by-product
Total Total
Cost Total Total Cost
( Invent Cost Cost Total ( Inve
Sales ory ( Invent ( Invent Cost ntory
price Value) ory ory Gross ( Invento Value
per per Gross Value) Gross Value) Margi ry Value) Gross ) per Gross
Product ton ton Margin per ton Margin per ton n per ton Margin ton Margin
While
Flour 2100 1928 8.20% 2085 0.70% 2074 1.20% 2060 1.90% 2076 1.10%
Suji 2480 1934 22% 2454 1.10% 2449 1.20% 2480 0% 2444 1.50%
Wholem
eal
Flour 2000 1884 5.80% 1945 2.70% 1975 1.30% 2000 0% 1937 3.10%
Bran 1140 1866 -63.70% 1105 3% 1125 1.30% 1140 0% 1140 0%

Table VI
2. Sales value method:
This method is better than Physical Quantity method as we do not observe any loss
on any of the products. But if we adopt this method, we will have gross margin of
only 0.7% for the white flour, which is our main product. This might cause a concern
especially for the senior management.
3. Net Realization Value(NRV) method:
By this method we are getting a good and even profit margin among all the products.
Also we are getting a decent 1.2% gross margin (which is very close to our overall
margin) on our main product white flour.
4. Assuming all the three products other than white flour as by-products:
Name: Bhavinkumar Parmar, MAC-II
Roll No: 2010PGP084, Section A

In this method, as according to our assumption, we can see that we are getting a
profit margin of 0% on our main product, white flour. Also, we are observing a gross
margin of 1.9% on white flour.
We have to be careful when we use this method, because we should note that we
are allocating the extra joint costs of by-products to white flour. In case the market
prices of the three by-products fall, then it leads to an increase in overall cost of the
white flour and hence decreases its margin. Also, there will be a lot of volatility in the
cost allocation every time.
5. Treating only Bran as by-product:
From the table we can see that, if we adopt this method we are getting a gross
margin of at least 1.1% on the three joint products. Also, the inventory costs of the
three products bear some cost corresponding to Bran(as we assume it as by-
product).

Best solution:

From the above analysis, we can arrive at two final methods which we can adopt:

1. Net Realization Value method

2. Treating only Bran as By-Product

If we have to choose one method from these two, we can go for the Net Realization Value
method. The reason being, in the long term, it might happen that the selling price of Bran
changes and it leads to a change in the Inventory costs of other products too. So, to avoid
volatility in our values, we can go for the former method.

Lessons from the case:

From the case analysis, we can identify the following points as learnings:

a) When multiple products are produced using the same processes simultaneously, the
costs involved in the process (Joint costs) should be allocated after choosing an
allocation basis to arrive at the right costs for each product.
b) Physical distribution method though easy to implement, it can be used only when the
products produced from the process are of comparable value.
c) We should be careful when treating some of the products as by-products. Since we
will be allocating part of their joint costs to the main products, this increases the
inventory costs of our main product, which reflects on the balance sheet. So, we
should make sure that there is no significant impact because of this.
d) Finally, we should keep in mind that the cost allocation of joint costs should not
cause any change in the economic decisions of the firm. So, which ever method we
adopt should not have any impact on the managerial decisions made. These methods
should be viewed only from accounting perspective.
Name: Bhavinkumar Parmar, MAC-II
Roll No: 2010PGP084, Section A