Textbook Title: Managerial Accounting

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Chapter 12, Problem 29C

Problem

Sell or Process Further Decision

The Scottie Sweater Company produces sweaters under the Scottie label. The company buys raw wool and processes it into wool yarn from which the
sweaters are woven. One spindle of wool yarn is required to produce one sweater. The costs and revenues associated with the sweaters are given below:

Originally, all of the wool yarn was used to produce sweaters, but in recent years a market has developed for the wool yarn itself. The yarn is purchased by
other companies for use in production of wool blankets and other wool products. Since the development of the market for the wool yarn, a continuing dispute
has existed in the Scottie Sweater Company as to whether the yarn should be sold simply as yarn or processed into sweaters. Current cost and revenue data on
the yarn are given below:

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The market for sweaters is temporarily depressed, due to unusually warm weather in the western states where the sweaters are sold. This has made it necessary
for the company to discount the selling price of the sweaters to $30 from the normal $40 price. Since the market for wool yarn has remained strong, the dispute
has again surfaced over whether the yarn should be sold outright rather than processed into sweaters. The sales manager thinks that the production of sweaters
should be discontinued; she is upset about having to sell sweaters at a $2.50 loss when the yarn could be sold for a $4.00 profit. However, the production
superintendent does not want to close down a large portion of the factory. He argues that the company is in the sweater business, not the yarn business, and the
company should focus on its cure strength.

All of the manufacturing overhead costs are fixed and would not be affected even if sweaters were discontinued. Manufacturing overhead is assigned to
products on the basis of 150% of direct labor cost. Materials and direct labor costs are variable.

Required:

1. What is the financial advantage (disadvantage) of further processing one spindle of wool yarn into a sweater?

2. Would you recommend that the wool yarn be sold outright or processed into sweaters? Explain.

3. What is the lowest price that the company should accept for a sweater? Support your answer with appropriate computations and explain your
reasoning.

Step-by-step solution

1. Step 1 of 7

Decision making:

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 Sell or process further decision:

Decision making plays a vital role in sustainability and growth of firms. A firms decision making is said to be optimum when it could choose and
adapt a best financial alternative among the available ones. All the decisions that whichever firms use to take mostly will have a direct or an indirect
monetary impact. Thus as the decisions made reflect financial transactions of company in one way or other, managers need to evaluate all the available
alternatives well; analyze the outcomes of evaluation and choose the best. Selling or processing further is an accounting decision that which determines
comparison in value of profit firm could earn in selling as semi processed goods and selling as finished product.

2. Step 2 of 7

1.

Maximum possible yarn must be processed into sweaters. Usually products should be processed so long as added revenues are more than added costs.
Here in this case the added revenues and costs are,

3. Step 3 of 7

4. Step 4 of 7

Therefore, the firm gains an advantage of added contribution margin of $2.20 per each spindle of yarn that is processed as sweater. Here we ignore fixed
costs of $16.00 as they are indifferent between selling yarn and processing yarn further into sweaters. Also manufacturing costs are ignored as they are
relevant in computing when yarn is sold.

5. Step 5 of 7

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 2.

The wool yarn is suggestible for processing further into sweaters rather than selling yarn outright. This is because processing wool yarn further has
generated a gain of contribution margin $2.20. However, if the costs of button, thread, lining or direct labor increases from $7.80 then the firm has to
choose for selling wool yarn outright rather than processing further into sweaters.

6. Step 6 of 7

3.

Calculation of Acceptable Lowest Price:

With the substitution of given values in the above equation the acceptable lowest price for a sweater is found as,

Therefore, the acceptable lowest price per each sweater is $27.80

If the wool yarn is sold outright then the contribution margin will be,

Therefore, selling wool yarn outright will generate a contribution margin of $9.40 which is an opportunity cost. The opportunity costs need to be covered
with selling price and variable costs need to be covered by firm from time of raw wool purchase to sweater completion. The minimum price calculation is
shown in following table.

7. Step 7 of 7

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 Hence, minimum selling price per sweater is .

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