A Cost Accounting Decision: Sell or Process Further?
In cost accounting, a sell or process further decision asks whether to sell a product “as is” at the splitoff point, or to process further. The splitoff point is the point when the costs of two or more products can be separately identified. There are two criteria you use to justify further processing (and more costs):
If the product has a sales value at splitoff, maybe it’s better to sell it.
If the incremental revenue from further processing is greater than the incremental cost of further processing, maybe it’s better to continue processing.
Some products simply don’t have a sales value at splitoff. The product’s production isn’t far enough along for it to be sold yet. No customers (or not enough customers) would consider buying the product at splitoff. Think about selling blue jeans without zippers or belt loops; it’s probably not a good idea.
If you can’t calculate a sales value at splitoff, there’s no “sell or process further” decision to make. To have a viable product to sell, you need to keep processing.
But wait! There are times when a partially completed product at splitoff has value to someone. Say you make cabinets. You’ve run production on two types of products, and you’re now at splitoff. Neither type of cabinet is ready to be sold to a customer because you have to complete the sanding and finishing on the wood. You also have to install metal handles.
The product is clearly not ready for a regular customer (likely a retail store that sells to the public). However, another business may ask you for a price quote for the partially completed goods. Maybe another cabinetmaker is having trouble filling a large order. It might be willing to buy your partially finished cabinets. In that scenario, you essentially become an industry supplier.
Keep your thinking cap on! Maybe you can build a business selling unfinished cabinets without hardware to the do-it-yourself (DIY) market. In that case, there is sales value at splitoff.
Joint costs are irrelevant for your “sell or process further” decision. Those costs are the same, whether you sell the product at splitoff or process further. In this case, joint costs are sunk or past costs. In other words, they’ve already been paid.
Incremental revenue is the additional revenue you get from selling one more unit that has been processed further. Incremental cost is the additional cost. If you spend $5 more per unit, and earn $7 more from selling that unit, your incremental revenue is $2 higher than the incremental cost. Incremental, in this case, refers to the production from splitoff to a completed product.