Sell or Process Further

26/08/2021 0 By indiafreenotes

The sell or process further decision is the choice of selling a product now or processing it further to earn additional revenue. This choice is based on an incremental analysis of whether the additional revenues to be gained will exceed the additional costs to be incurred as part of the additional processing work.

For example, if a green widget can be converted into a red widget at an incremental cost of Rs. 1.00 per unit, then processing further is a good idea as long as the incremental price gain to be achieved is at least Rs. 1.01 per unit.

The decision to sell now or process further boils down to which choice will result in higher profits. Split-off point refers to the moment in the manufacturing process when different products become separately identifiable.

If the incremental sales revenue is greater than incremental costs, it makes sense to process further. Otherwise, it is better to sell at the split-off point.

The sell or process further decision most commonly arises when two or more products are generated by a manufacturing process. At the point when the products can be split apart (the split-off point), there is a choice to sell the goods immediately or attempt to capture additional value by engaging in more processing. This decision may vary over time, based on changes in the market prices of a product at each stage of processing. If the market price declines for a later-stage product, it can make more sense to sell it without additional processing. Conversely, if the market price increases for a later-stage product, the better choice may be to continue with additional processing in order to reap higher profits.

Example

Hyderabad XYZ Company manufactures three products. In one production batch, the company incurs Rs.25,000 manufacturing costs up to the split off-point (the point in the manufacturing process when the products can be separately identified). The following summarizes the further processing costs beyond the split-off point and ultimate sales value.

  Further processing costs   Expected
sales revenue
Product 1 Rs.72,000   Rs.90,000
Product 2 Rs.12,000   Rs.28,000
Product 3 Rs.2,000   Rs.12,000

The company can sell the products at split-off point. The expected sales revenues at split-off point are: Product 1 – Rs.24,000, Product 2 – Rs.8,000, Product 3 – Rs.7,000. Which products should be sold at split-off point and which products should be processed further?

Solution:

  Product 1   Product 2   Product 3
Increase in sales Rs. 66,000   Rs.20,000   Rs.5,000
Increase in costs 72,000   12,000   2,000
Effect to profits (Rs.6,000)   Rs.8,000   Rs.3,000

Product 1 should be sold at split-off point. The increase in sales revenue amounting to Rs.66,000 (i.e., from Rs.24,000 to Rs.90,000) is less than the costs to process the product further (Rs.72,000). Hence, it is better to sell the product at split-off point than process it further. Product 2 and Product 3 could be processed further since it will result in incremental profits.