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?

Help me answer these please! Thank you!

Answer 1

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

a) If as a result of processing the product further, additional sales revenue exceeds additional costs, the wise decision is to process further. However, If additional sales revenue is less than additional costs to be incurred in processing that material the same should be sold at split off only. Any costs incurred prior to the split-off point are irrelevant to the decision to process further, as those are sunk costs, and only future costs are relevant costs.

b) Non financial considerations:

• Meeting the requirements of current and future legislation : The by-product generated by the company might be hazardous if same is disposed directly without further processing. Hence, there might be statutory requirement to further process it.
• Improving staff morale and improving business reputation and relationships with the local community: There might be employees and poor workers who must be earning their livelihood through working in that processing plant, Shutting down those plants just by referring financial terms might harm company's image in long term.
• Developing the capabilities of business, such as building skills and experience in new areas or strengthening management systems
• Anticipating and dealing with future threats, such as protecting intellectual property against potential competition

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

• The capacity required to fulfill the special order

If the company does not have the capacity to produce a special order, it will have to reduce production of another good or service in order to fulfill the special order or provide another means of producing the goods, such as hiring temporary workers, running an additional shift, or securing additional equipment etc.

• Whether the price offered by the buyer will cover the cost of producing the products

Management must determine if the price offered by the buyer will result in enough revenue to cover the differential costs of producing the items. For example, if price does not meet the variable costs of production, then accepting the special order would be an unprofitable decision.

• The role of fixed costs in the analysis

Fixed costs may be relevant if the company is already operating at capacity, as there may be additional fixed costs, such as the need to run an extra shift, hire an additional supervisor, or buy or lease additional equipment. If the company is not operating at capacity—in other words, the company has unused capacity—then the fixed costs are irrelevant to the decision if the special order can be met with this unused capacity.

• Qualitative factors

A logical issue is the concern for how existing customers will feel if they discover a lower price was offered to the special-order customer. A special order that might be profitable could be rejected if the company determined that accepting the special order could damage relations with current customers