Additional Processing Decisions
Example 1 Additional Processing
Fresh Veggies
Fresh Veggies, Inc., purchased 10,000 pounds of fresh apples from a local grower for $4,000. The apples were separated into high-quality Grade A apples (3,000 pounds) and lower-quality Grade B apples (7,000 pounds). Fresh Veggies sells Grade A apples for $0.80 per pound and Grade B apples for $0.50 per pound.
| Grade A Apples | Grade B Apples | Total | |
| Sales Revenue | $2,400 | $3,500 | $5,900 |
| Joint Costs Allocated | 1,200 | 2,800 | 4,000 |
| Profit before additional processing | $1,200 | $700 | $1,900 |
| Additional processing costs | 1,400 | 1,400 | |
| Additional processing revenue | 1,050 | 1,050 | |
| Additional profit (loss) | (350) | (350) | |
| Profit after additional processing | $350 | $1,550 |
Fresh Veggies has the option to process Grade B apples into dried apples for an additional cost of $.20 per pound and sell them for an additional $.15 per pound.
Since the profit before additional processing of $1,900 is greater than the profit after additional processing of $1550 Fresh Vegetable should not process the Grade B apples further into dried apples. In other words, because the additional revenue of $0.15 per pound is less than the additional $0.20 per pound processing cost, Fresh Veggies should not process the Grade B apples further into dried apples. Profit decreases $0.05 per pound or a total of $350 as a result of processing further.
Example 2 Additional Processing
Luxury Leathers, Inc.
Luxury Leathers, Inc., produces various leather accessories, such as belts and wallets. In the process of cutting out the leather pieces for each product, 400,000 pounds of scrap leather is produced. Luxury has been selling this leather scrap to Sammy’s Scrap Procurement for $2.25 per pound. Luxury has an employee suggestion box and one of the suggestions was to use most of the scrap to make leather watch bands. The management of Luxury is interested in this idea as the machines necessary to produce the watch bands are the same as the ones used in making belts and would merely need reprogramming for the cutting and stitching processes on the watch bands. The process to attach the buckle would be the same for the watch bands as it was for the belts, thus this would require no additional worker training. Luxury would have additional costs for new packaging and for the supply and insertion of the pins that connect the band to the watch. The total variable cost to produce the watch band would be $2.85. Fixed costs would increase by $85,000 per year for the lease of the packaging equipment, and Luxury estimates it could produce and sell 100,000 watch bands per year. Finished watch bands could be sold for $15.00 each.
Should Luxury continue to sell the scrap leather or should Luxury process the scrap into watch bands to sell?
Sell at Split-Off | Process Further | |
| Selling price per lb of scrap | $2.50 | |
| Selling price per watch band | $15.00 | |
| Variable costs to sell per unit | $2.85 | |
| Contribution margin | $12.15 | |
| Units sold | 400,000 | 100,000 |
| Total contribution margin | $900,000 | $1,215,000 |
| Additional fixed costs | 0 | 85,000 |
| Effect on income | $900,000 | $1,130,000 |
Luxury should process the leather scrap further into watch bands. Not only does the act of processing the scrap further result in an increase in operating income of $230,000, it offers Luxury another product line that may draw customers to its other products.