Deciding at What Stage
Deciding at What Stage
to Sell a Product
In some companies, all the products evolve out of a joint manufacturing process, meaning that one material input is used to produce more than one product. Gasoline, oil, and kerosene, for example, are all produced from refining crude oil; various cuts of beef are provided from butchering a steer; and different qualities and types of lumber are available from processing timber. In all these cases, the products are produced simultaneously and are not individually identifiable until the split-off point in the process. When this is the case, management must decide whether a particular product from the joint manufacturing process should be sold as is, or processed further at additional cost, with the expectation of obtaining a higher price.
In choosing the best time to stop processing a product, management basically compares the additional costs that would be incurred from further processing with the additional revenues. If the revenues are greater than the costs, net income is increased, and additional processing is worthwhile (unless qualitative factors dictate otherwise). If the revenues are less than the costs, the product should probably be sold without further processing. The costs that a firm incurs before the point at which the different products are separated for further processing or immediate sale are called joint product costs. These costs are incurred whether the separate products are sold at the point of separation or after further processing. Thus, they are not relevant to a choice between the two alternatives.
To illustrate the decision-making process related to further processing, we will assume that Armaco Oil Company derives two products, jet fuel and reformate, from crude oil. Although crude oil cannot be sold independently, both jet fuel and reformate can be, either at the point of separation or after further processing. Further processing jet fuel results in a petrochemical product called xylene, while further processing of reformate results in a petrochemical called tolulene. The cost of refining 375,000 gallons of crude oil up to the point of separation is $300,000. Crude oil is then separated into 200,000 gallons of jet fuel and 150,000 gallons of reformate. The remaining 25,000 gallons are lost in the process of refining. The selling prices of jet fuel and reformate at the point of separation, the costs of processing further, and the selling prices after this further processing are estimated by the accounting department to be:3
Net Selling
Net SellingPrice of Xylene
Price perAdditionaland Tolulene per
Gallon atProcessingGallon After
GallonsSeparationCostsProcessing
Jet fuel200,000$1.20$80,000$1.70 (Xylene)
Reformate150,0001.0090,0001.50 (Tolulene)
To help management decide whether to sell jet fuel or reformate at the point of separation or to process them further, the following analysis might be prepared.
Product: Jet Fuel/Xylene
Sales revenue after further processing (200,000 gallons at $1.70) $340,000
Sales revenue at point of separation (200,000 gallons at $1.20) 240,000
Additional revenue from further processing $100,000
Additional processing costs 80,000
Additional profit from further processing $20,000
Product: Reformate/Tolulene
Sales revenue after further processing (150,000 gallons at $1.50) $225,000
Sales revenue at point of separation (150,000 gallons at $1.00) 150,000
Additional revenue from further processing $75,000
Additional processing costs 90,000
Additional loss from further processing $(15,000)
This analysis shows that further processing of jet fuel into xylene will contribute an additional $20,000 to net income, because the additional revenues generated exceed the additional processing costs by $20,000. On the other hand, further processing of reformate into tolulene will reduce net income by $15,000, because the additional processing costs are greater than the additional revenues by that amount. Therefore, reformate should be sold at the point of separation.
Exhibit 21–7
A Comparison of Alternatives: Selling at Point of Separation or After Further Processing
Sell BothSell ReformateSell Jet Fuel
Sell BothProductsat Separationat Separation
Products atAfter Furtherand Processand Process
SeparationProcessingJet Fuel FurtherReformate Further
Sales revenue:
Jet Fuel/Xylene $240,000 $340,000 $340,000 $240,000
Reformate/Tolulene 150,000 225,000 150,000 225,000
Total sales revenue $390,000 $565,000 $490,000 $465,000
Joint product costs $300,000 $300,000 $300,000 $300,000
Further processing costs 0 170,000 80,000 90,000
Total costs $300,000 $470,000 $380,000 $390,000
Net income $90,000 $95,000 $110,000 $75,000
A total cost approach to analyzing this decision is shown in Exhibit 21–7. Selling both products after further processing increases net income by $5,000, but the best choice is to sell reformate at the point of separation and to process jet fuel into xylene before it is sold. The worst choice is to sell jet fuel at the point of separation and further process reformate, resulting in only $75,000 of profit. Note that the joint processing costs were not considered in the earlier analysis of the individual products since they are not differential costs but are the same for each alternative. In the later analysis of the alternative treatments of jet fuel and reformate, however, the joint costs are included simply to illustrate the total-cost approach. But they are not really necessary since the difference in net income is the same whether or not the $300,000 of joint costs are included.
In deciding whether to sell products at the point of separation or after further processing, management must also consider qualitative factors. For example, management will need to consider quality and time issues, as well as the hiring or firing of employees and customers’ demands for particular products.