1. Cost Accounting for Decision-making
Lesson 8

2. Different Types of Business Decisions (Sell or Process Further)
Part III
Different Types of Business Decisions
(Sell or Process Further)

3. Five Types of Business Decisions
Hire, make or buy
Accept or reject an order at a special price
Eliminate or retain an unprofitable segment
Retain or replace equipment
Sell or process further
Teacher highlights the fifth type of decision-making situation – sell or process further.

4. Sell or Process Further Decisions
Some companies are able to sell their products at different stages of completion. Example: Companies in food processing and natural resources industries.
In deciding when should the sales be made, the following will be considered:
How much revenue can we get if we sell the products now?
How much net benefit can we gain if we sell the products after further processing?
Teacher explains that there are cases that profit from selling will be higher if the company further processes the product. 4

5. Sell or Process Further Decisions
DECISION RULE
If extra benefits from further processing > extra costs of further processing
Process further
If extra benefits from further processing < extra costs of further processing
Do not process further
Teacher explains the decision rule to sell or process further a product.

6. Example for Sell or Process Further Decisions
Suki grows peaches in Japan. She can either sell them to the local supermarket after harvest, or further process them into peach juice for selling to the tourists in farmers’ market. In the former case, Suki can sell the peaches in 2.5 kg per box at 100 boxes for $500 each; in the latter case, she can make 3,000 cups of juice with additional costs of $4 per cup for $28 each.
Should Suki sell the peaches in boxes or further process them into peach juice?
Teacher uses the example to illustrate a sell or process further decision.

7. Points to Note for Making the Decision
What is the revenue from selling the peaches in boxes?
What is the net benefit from processing the peach into juice?
Compare the difference and make a conclusion.
Teacher explains some points that are relevant to make the decision.

8. Suggested Solution Revenue from selling the peaches in boxes
Net benefit from further processing
= ($28 - $4) x 3,000 = $72,000
Suki should further process the peaches into peach juice because she will earn $22,000 ($72,000 - $50,000) more.
Teacher explains the solution and makes a conclusion.

9. Classwork
Alan Company has 10,000 units of unfinished ‘Model A’ on hand, each of which had already incurred a production cost of $80. The company can either sell them at their current state for $90 each, or to complete the product at a cost of $15 per unit for $107. Total fixed costs relating to the production of the ‘Model A’ is $42,000.
Should the company sell ‘Model A’ at present or process further?
Teacher asks students to do the calculations

10. Suggested Solution Net benefit / (loss) from process further$
Incremental revenue ($107 - $90) x 10,000
170,000
Less: Further processing cost ($15 x 10,000)
150,000
Net benefit from process further
20,000
Teacher explains the solution.
Remarks: Total fixed costs remain the same regardless if the ‘Model A’ is processed further or not. They are irrelevant for making decision in this case.
Alan Company should further process the ‘Model A’ because it will earn $20,000 more.

11. Summary

12. Types of Relevant and Irrelevant Costs
Future incremental costs
Sunk costs
Opportunity costs
Non-cash expenses
e.g. Depreciation
Avoidable fixed costs
Unavoidable / Allocated general costs
Variable costs saved
Teacher summarize all types of relevant costs and irrelevant costs that students have learned.

13. Five Types of Business Decisions
Question
Decision
1. Should a company outsource a component?
If incremental cost of outsourcing > incremental cost of making, then outsource that component.
2. Should a company accept an order at a special price?
If expected increase in revenues > expected increase in variable and fixed costs, then accept the order.
3. Should a company eliminate a segment?
If that segment has a negative margin, then eliminate that segment.
Teacher summarizes the types of business decisions that students have learned.

14. 4. Should a company replace a new machine or retain the old one?
Decision
Guidelines
4. Should a company replace a new machine or retain the old one?
If the incremental costs of retaining > the incremental costs for replacing, then replace the new machine.
5. How should a company decide whether to sell a product as is or process further?
If extra benefit from further processing > extra cost of further processing, then process further.
Teacher summarizes the types of business decisions that students have learned.

15. Conclusion
As a conclusion, managers have to use both financial and non-financial information in making rational decisions. If they can apply the costing concepts and techniques in making business decisions, they are able to allocate resources more efficiently and at the same time minimize their business risks for higher profitability.

16. Homework: Q9 and 10
Teacher asks students to do Questions 9 and 10 at home.

17. END