Accounting

Replacement Cost Method: A Method of By Product Costing

Replacement cost method of By-products costing: The replacement cost method is used, ordinarily, by firms whose by products resulting from the manufacturing processes are used  Within the plant thereby avoiding the necessity of purchasing certain and supplies from outside suppliers. Production costs of the main product, however, receive credit for furnishing such materials.

The cost assigned to the by-product is the purchase or replacement cost existing in the market. Replacement cost method is particularly common in the steel manufacturing industry. Although a number of by-products are sold in the open market, other products such as blast furnace gas and coke oven gas are mixed and used further for heating in open hearth furnaces. The waste heat from open hearths is again used in the generation of steam needed by the various producing departments. The resourceful use of these by-products and their accounting treatment is indicated by the following procedure used by a steel company:

1. Coke oven by-products are credited to cost of coke at average sales price per unit for the month.
2. Coke oven and blast furnace gas are credited respectively to cost of coke and cost of pig iron at computed value based on cost of fuel oil yielding equivalent heat units.
3. Tar and pitch used as fuel are credited respectively to cost of coke at computed value based on cost of fuel oil yielding equivalent heat units.
4. Scrap steel remolded is credited to cost of finished steel at market cost of equivalent grades purchased.

5. Waste heat from furnaces used to generate steam is credited to steel ingot cost at computed value based on cost of coal yielding equivalent heat units.

Replacement cost method of By-products costing is popularly used in manufacturing industries.

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