Additional Product Processing - New Project 5

In a sell-or-process-further decision, the fundamental rule is to process further as long as the incremental revenue from processing exceeds the incremental processing costs. This rule focuses on the additional revenues and costs that are relevant to the decision to process further.

Incremental revenue is the additional income that can be earned from selling a product after it has undergone additional processing, compared to the revenue from selling the product in its current state. To determine incremental revenue, a company calculates the revenue from selling the product after processing and subtracts the revenue from selling the product before any additional processing. Projecting the expected revenue from selling the processed product involves market research to establish the potential selling price and the quantity expected to be sold.

Incremental processing costs refer to the additional costs incurred when a company decides to process their product further. These costs only reflect changes specifically associated with the additional processing steps. Unlike total costs, which include both fixed and variable expenses, incremental processing costs focus solely on costs that will vary with the decision to process. These relevant costs include additional materials, labor, and overhead costs that will only be incurred if the decision is made to process further. Identifying these costs is important because they determine if the decision to process further is financially beneficial, and only those costs that increase due to processing should be considered. Based on the decision rule, the correct comparison involves only costs that will change due to the decision to process further, which are incremental processing costs. Therefore, the decision to process further should be made if incremental revenue exceeds incremental processing costs.

To systematically analyze whether to sell or process further, companies often use a structured approach. This involves calculating relevant costs, estimating incremental revenue, and performing an incremental cost analysis. The net benefit can be summarized as Incremental Revenue minus Incremental Costs. If the net benefit is positive, further processing may be justified. Companies may also conduct a sensitivity analysis to see how changes in variables like prices, costs, and demand could affect the decision. Qualitative factors such as customer preferences and brand reputation should also be considered.

The implications of choosing to sell or process further can be significant.

In some production processes, multiple products result from a common raw material or process; these are called joint products. Joint costs are those costs incurred up to the point where the joint products split off from each other. These costs are sunk costs and are not considered when deciding whether to process a joint product further before selling it or to sell it in its condition at the split-off point. Only future costs that are relevant to the decision to process further should be considered.