Process Further Decisions Managerial Accounting Prepared by Diane Tanner University of North Florida Chapter 22

Further Processing Decisions  A company must often decide if it should sell a product ‘as is’ or process it further. May involve  Units of inventory that are obsolete  Units of inventory that are partially complete  Decision should be based on profitability  The goal is to maximize profit The decision: Should the product be sold ‘as is’ or processed further? 2

Process Further Amounts Not relevant  Most fixed costs  Any costs incurred up to the split-off point—the point at which the decision is being made 3 Incremental Revenue The additional revenues generated from processing the product further (enhancing its sales value) Incremental Costs The additional costs incurred to process the product further

How to Make Process Further Decisions Use qualitative characteristics to assess 4 If incremental revenues < incremental costs Sell as-is, unless qualitative characteristics impact the decision If incremental revenues > incremental costs Process further, unless qualitative characteristics impact the decision If incremental revenues = incremental costs

Process Further Example A company manufactures two models of door locks using the same production process. The costs incurred up to the split-off point are allocated $100,000 to each model. Additional data follows: 5 Product Number of Units Produced Selling Price at Split-off Selling Price after Processing Additional Processing Costs X5,000$10.00$15.00$14,000 Z4, ,000 Prepare an incremental analysis for product X. Incremental revenue (5,000 x ($15 - $10))$25,000 Incremental costs (14,000) Incremental increase in profit if processed further$11,000 Incremental revenue (5,000 x ($15 - $10))$25,000 Incremental costs (14,000) Incremental increase in profit if processed further$11,000 Process further because profit is expected to increase by $11,000.

6 The End