Question

1. What are the key elements that determine if we should process an item further or sell it at the split off point?

2. What are the key points we should consider in deciding whether to accept a special order?

Answer 1

1. Key elements that determine if we should process an item further or sell it at the split off point

• Differential Revenue should be calculated by seeing the revenue between Sales at split off point and Final sales value
• Further processing cost should be determined
• If the there is incremental contribution by deducing the further processing cost form the differential revenue the product should be further processed. If there is no incremental contribution the item should be sold at split off of point
• Joint costs are sunk costs in deciding sell at split off point or process further
• Only further processing costs are relevant cost in decision making

2. Key points we should consider in deciding whether to accept a special order

• Capacity utilization is the first important relevant factor. If there is excess capacity only variable cost and incremental fixed cost are relevant cost. If there is full capacity utilization, Variable cost plus incremental fixed cost and Contribution forgone for existing units will be relevant cost
• While evaluation of special order only relevant costs should be considered in evaluation of the offer
• Variable costs are relevant cost. Variable costs are direct material, direct labor, variable manufacturing cost, variable selling costs and variable administrative costs.
• Existing fixed costs are sunk cost and irrelevant in decision making.
• Only incremental fixed costs if any due to special order are relevant costs
• If there is incremental contribution after deducting incremental costs from special order revenue the special order should be accepted else it should be rejected