Physical Measure and Average Cost Methods
The Physical Measure and Average Cost methods are essentially the same. In the Physical Measure method, the joint cost allocation is done based on the weight, volume, or other physical measure of the joint products, such as pounds, tons, or gallons. In the Average Cost method, the joint cost allocation is done based on the physical units of output. In both methods, joint costs are allocated proportionately among the joint products, so that each product is allocated the same amount of joint cost per unit of measure, whether that unit is a unit of physical measure or a unit of output.
Physical Measure Method
Joint cost allocation may be done based on the weight, volume, or other physical measure of the joint products. Joint costs are allocated based on some common unit of measurement of output at the split off point, such as pounds, tons, gallons, or board feet (for lumber). The Physical Measure method may also be called the Quantitative Unit method.
The total joint cost up to the split off point is prorated between or among the joint products based on the physical measure being used. It stands to reason that it must be possible to measure all the joint products using the same unit of measurement. If all the output that results from a joint process cannot be measured in the same terms—for instance, if some of the output is liquid and some of the output is dry— the Physical Measure method cannot be used.
Average Cost Method
The Average Cost method may also be called the Physical Unit method. It is used when the joint costs are to be allocated on the basis of physical units of output in completed form. It is basically the same as the Physical Measure method, but because physical units of completed product are used, it is called by the name Average Cost, or sometimes Average Unit Cost method.
The total joint cost is divided by the total number of units of all the joint products produced to calculate the average cost per unit. Then that average cost per unit is multiplied by the number of units of each product produced to find the amount of cost to be allocated to each product.
Benefits of the Physical Measure and Average Cost Methods
- The Physical Measure and Average Cost methods are easy to use.
- The allocation is objective.
- The methods are useful when rates or prices are regulated.
Limitations of the Physical Measure and Average Cost Methods
- The Physical Measure and Average Cost methods can result in product costs that are greater than the market values for some of the joint products. The physical measures of the individual products may have no relationship to their respective abilities to generate revenue. If weight or size is used, the heaviest or largest product will be allocated the greatest amount of the joint cost; but that product may have the lowest sales value. Products with a high sales value per weight or size would show large profits, while products with a low sales value per weight or size would show large losses.
- Physical measures are not always comparable for products. For example, some products might be in liquid form (for example, petroleum), whereas some might be in gaseous form (for example, natural gas). When the physical measures used for the joint products differ, this method cannot be used.