10.5 Evaluate and Determine Whether to Sell or Process Further
3 min read•june 18, 2024
Joint product costing and sell or process further decisions are crucial in industries like oil refining and lumber processing. These choices impact profitability by weighing the costs and benefits of selling products at split-off points versus further processing.
Managers must consider , incremental revenues, and when making these decisions. By focusing on financial impacts and production characteristics, companies can optimize their strategies to maximize profits and efficiently utilize resources.
Joint Product Costing and Sell or Process Further Decisions
Financial impact of split-off decisions
Top images from around the web for Financial impact of split-off decisions
Budgeted Income Statement | Managerial Accounting View original
Is this image relevant?
Accounting Information | Boundless Business View original
Is this image relevant?
6.3 Comparing Absorption and Variable Costing | Managerial Accounting View original
Is this image relevant?
Budgeted Income Statement | Managerial Accounting View original
Is this image relevant?
Accounting Information | Boundless Business View original
Is this image relevant?
1 of 3
Top images from around the web for Financial impact of split-off decisions
Budgeted Income Statement | Managerial Accounting View original
Is this image relevant?
Accounting Information | Boundless Business View original
Is this image relevant?
6.3 Comparing Absorption and Variable Costing | Managerial Accounting View original
Is this image relevant?
Budgeted Income Statement | Managerial Accounting View original
Is this image relevant?
Accounting Information | Boundless Business View original
Is this image relevant?
1 of 3
- Determine the sales value of the product at the establishes a baseline for comparison (crude oil, lumber)
- Calculate the additional revenue generated by processing the product further to understand the potential financial gains (gasoline, furniture)
- Identify the additional costs incurred to process the product beyond the such as labor, materials, and overhead (refining, manufacturing)
- Compare the to the incremental costs to determine the financial impact
- If incremental revenue exceeds incremental costs, processing further is more profitable as it generates a positive return (refined sugar)
- If incremental costs exceed incremental revenue, selling at the split-off point is more profitable as further processing would result in a financial loss (raw diamonds)
Relevant costs for processing decisions
- are irrelevant as they are incurred regardless of the decision to sell or process further and cannot be changed (mining, farming)
- Relevant costs include:
- Additional processing costs beyond the split-off point such as labor, materials, and overhead (refining, packaging)
- Opportunity costs, such as the foregone revenue from selling the product at the split-off point represent the potential income lost by choosing to process further (crude oil, raw lumber)
- Relevant revenues include:
- Additional revenue generated by processing the product further and selling it at a higher price (gasoline, furniture)
- Revenue from selling the product at the split-off point without incurring additional processing costs (raw diamonds, unrefined sugar)
Joint costs in further processing
- Joint costs do not affect the decision as they are incurred before the split-off point and cannot be changed or avoided (mining, farming)
- Production characteristics to consider:
- Product quality at the split-off point
- If the product meets customer requirements, selling at the split-off point may be more viable as further processing may not significantly increase value (raw diamonds)
- Market demand for the product at various stages of processing
- Higher demand for the processed product may justify further processing to meet customer preferences (gasoline, furniture)
- Capacity constraints and bottlenecks in the production process
- Limited capacity may prioritize products with higher profitability or selling at the split-off point to maximize and minimize costs (crude oil, raw lumber)
- Availability and cost of resources required for further processing
- Scarce or expensive resources may make selling at the split-off point more attractive to conserve resources and minimize costs (rare metals, exotic wood)
- Product quality at the split-off point
Incremental Analysis for Decision Making
- Evaluate incremental revenue: Additional income generated from further processing compared to selling at the split-off point
- Assess : Extra expenses incurred for additional processing beyond the split-off point
- Consider : The potential benefit foregone by choosing one alternative over another
- Analyze bottlenecks: Identify production constraints that may limit further processing capabilities
- Measure throughput: Evaluate the rate at which the production system generates money through sales to optimize decision-making
Key Terms to Review (21)
Bottleneck: A bottleneck is a point of congestion in a production process where the workload exceeds the production capacity, causing delays and inefficiencies. It limits the overall output and affects decision-making regarding resource allocation.
Bottleneck: A bottleneck refers to a constraint or limitation in a system that restricts the overall output or throughput of that system. It is a critical point where the capacity of a process or resource is lower than the demand placed upon it, creating a constraint that impedes the efficient flow of the system.
Contribution margin: Contribution margin is the amount remaining from sales revenue after variable expenses have been deducted. It is used to cover fixed expenses and contribute to profits.
Contribution Margin: Contribution margin is the amount of revenue that remains after deducting the variable costs associated with producing a product or service. It represents the portion of sales revenue that contributes to covering fixed costs and generating profit. This concept is crucial in understanding the financial performance and decision-making processes of organizations, whether they are merchandising, manufacturing, or service-based entities.
Differential analysis: Differential analysis is the process of comparing the financial differences between decision alternatives. It focuses on identifying relevant costs and revenues that change under different courses of action.
Differential Analysis: Differential analysis is a decision-making tool that focuses on identifying and evaluating the relevant incremental costs and benefits associated with alternative courses of action. It helps managers make informed decisions by isolating the differences between options and understanding the financial implications of each choice.
Further Processing Point: The further processing point is the point in the production process where a decision must be made to either sell the product as is or to invest additional resources to process the product further. This decision is a critical component of evaluating whether to sell or process a product further, as outlined in the topic 10.5 Evaluate and Determine Whether to Sell or Process Further.
Incremental Cost: Incremental cost refers to the additional cost incurred when producing one more unit of a product or service. It is the change in total cost resulting from a small change in the level of output or activity, holding all other factors constant.
Incremental Revenue: Incremental revenue refers to the additional revenue generated from a new product, service, or business activity. It represents the change in total revenue resulting from the introduction or expansion of a specific offering, compared to the previous state of the business.
Incrementalism: Incrementalism is a decision-making approach that focuses on making small, gradual changes rather than implementing large, comprehensive reforms. This method allows organizations to adapt and respond to changes in a more manageable way, often assessing the impacts of each small decision before proceeding further. It is particularly relevant in situations where uncertainty exists or when the consequences of major changes are difficult to predict.
Joint costs: Joint costs are the costs incurred in a joint production process, where multiple products are produced simultaneously up to a certain split-off point. These costs cannot be easily traced to individual products until the split-off point is reached.
Joint Products: Joint products refer to two or more products that are produced simultaneously from the same raw materials or production process. These products are not easily separable and have a fixed proportional relationship in their production. The decision to sell or process joint products further is a crucial consideration in cost accounting and managerial decision-making.
Net Realizable Value: Net Realizable Value (NRV) is the estimated selling price of an asset in the ordinary course of business, less the estimated costs of completion and the estimated costs necessary to make the sale. It represents the amount an entity expects to realize from the sale of an inventory item or other asset.
Opportunity Cost: Opportunity cost is the value of the next best alternative that must be forgone in order to pursue a certain action or decision. It represents the trade-off involved in choosing one option over another and is a fundamental concept in economics and managerial decision-making.
Opportunity costs: Opportunity costs represent the potential benefits or profits an individual, investor, or business misses out on when choosing one alternative over another. It is a crucial concept in decision-making, helping to evaluate the relative profitability of different options.
Relevant Costs: Relevant costs are the future costs that are expected to change based on a decision being considered. These costs are important in evaluating alternative courses of action and making informed business decisions.
Sell-or-Process-Further Decision: The sell-or-process-further decision is a key concept in managerial accounting that involves evaluating whether a business should sell a partially completed product as is or invest additional resources to further process and refine the product. This decision is crucial in optimizing profitability and aligning production strategies with the company's overall goals.
Split-off point: The split-off point is the stage in the production process where joint products can be recognized as separate and distinct. It is the juncture at which common costs are allocated among the final products.
Split-off Point: The split-off point refers to the stage in the production process where a joint product can be separated into distinct, marketable products. It is the point at which the production process diverges, allowing the individual products to be sold or processed further independently.
Sunk Costs: Sunk costs refer to expenses that have already been incurred and cannot be recovered, regardless of future decisions. They are past costs that are irrelevant for future decision-making as they do not affect the incremental costs and benefits of a decision. Understanding the concept of sunk costs is crucial in various managerial accounting contexts, such as identifying relevant information for decision-making, evaluating make-or-buy decisions, determining whether to keep or discontinue a segment or product, and assessing whether to sell or process a product further.
Throughput: Throughput refers to the rate at which a system or process is able to produce, process, or deliver a particular output. It is a crucial concept in various business and operational contexts, including accounting, as it directly impacts the efficiency and productivity of an organization.
The term 'throughput' is particularly relevant in the context of 1.5 Describe Trends in Today's Business Environment and Analyze Their Impact on Accounting, 10.5 Evaluate and Determine Whether to Sell or Process Further, and 10.6 Evaluate and Determine How to Make Decisions When Resources Are Constrained. It highlights the importance of maximizing the output of a system or process while considering the available resources and constraints.