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in this video we're going to talk about the decision of whether to sell or process a joint product further so let's say that we have a dairy farm and we produce some raw milk at a cost of $300,000 and then there's a separation process which has $200,000 in cost we incur but it leads to two joint products we have whole milk and we have cream okay so these are our joint products and we can look at the sales value of each of these joint products at this point time so if we sold the cream now we'd get $360,000 if we sold the whole milk now we get $240,000 right so we could just go and sell these products right now but let's just say that there was a process that we could do we could do some additional processing and that would incur some incremental costs but that processing would enable us to sell these products for a higher dollar value right if we turn the cream into sour cream we could sell it for $500,000 instead of selling the cream for $360,000 right and also we could sell the the milk if we turn it into non-fat milk we sell it for 300,000 whereas if we just sell it for the whole milk let's say we get $240,000 so now here's the question do we just sell these products at this point in time right or do we do we do the additional processing and sell them at this point in time in which costs are relevant in terms of helping us make this decision so what you ultimately want to do is we want to take the incremental Revenue that we get from additional processing so the incremental Revenue minus the incremental costs okay so with this with the cream to sour cream what we're basically going to say is the incremental revenue is the sales value we get if we process it 500,000 minus the sales value it had before which is 360,000 so 500,000 minus 360,000 is $140,000 okay that's the incremental revenue from turning the cream into the sour cream now the incremental costs right we're going to say that let's say there's incremental cost of $150,000 here okay so it's going to be $150,000 and just bear in mind here I've just said that I'm just talking about the incremental cost of further processing there might be other costs of further processing like you have a specific machine or something that that turns the cream into sour cream and that machine requires some maintenance or something like that we're not going to get into all that here we're just going to make it simple and just say there's 150,000 of incremental costs but if there are costs that are not incremental then we don't want to worry about those right they've already been incurred so what happens here is we have a loss we would incur a loss of $110,000 for the sour cream right that we haven't got into the whole milk to milk yet we'll get into that separately but for turning the cream into to sour cream we're going to get an extra 140,000 Revenue but it's going to cost us an extra 150,000 so this is a bad idea we should not be doing the cream to the sour cream but now let's do the milk right so with the milk we'll say the incremental Revenue I'll just abbreviate rev here and then we've got the incremental cost right and we want to do the exact same thing and so we're going to say okay incremental revenue is 300,000 we'd get if it was processed all the way to non-fat milk minus the 240,000 that we could get right now as whole milk without any other processing so that's $60,000 we would boost our Revenue if we did the further processing now the incremental cost associated with further processing cing is $55,000 right so 55,000 so what does this mean well if we subtract the cost from the revenue that means we would get an additional $5,000 if we process the whole milk and turn it into non-fat milk so what should we do well yes yes we would process this further so the cream we say no do not process further but the whole milk the nonfilled milk we do process further now here's an important point there's a very important point when we're making this decision it looks obvious hey yes obviously we're going to do this but sometimes because a firm has allocated some joint some joint costs right so when you've allocated joint costs that can actually make it where it looks like it would not be profitable to do the further processing when in fact it it it that is the optimal thing to do let me give you an example make it a little easier to understand so remember we had $500,000 here in joint costs right so remember joint costs are just costs that are incurred prior to the split-off point right and the split-off point happens right here when the products become uniquely separable right so we've got whole milk and we've got cream at that point that's a split-off point and so the joint costs here the 500,000 and Joint costs let's just say that this firm had allocated 50% of those costs to the whole milk and 50% to cream right so 50% of 500,000 and the reason I got 500 just took the 300,000 to for the braw milk and 200 for the separation process if we take 50% of that we allocate half of those 500,000 to whole milk or to to one product line and half to the other then what we would have is the following we would have a situation where we'd be saying okay let's let's look at this non-fat milk we'd say 300,000 we ultimately get as the sales value for the non-fat milk milk and then we'd look and say okay now the incremental cost of processing is 55,000 right and then we say half of those half of those joint costs that we were talking about before so that's 250,000 and then now if we subtract all this here what do we get we get $5,000 okay so this is this is this is if we allocate 5050 you know 50% of joint costs 50% of joint cost so this makes it look like it is not profitable for us to make this non-fat milk right because we we just said hey look we just took the revenue we get from the non-fat milk and then we subtracted the costs and so but here's the problem this 250,000 this is just costs that have been allocated right all these joint costs these joint costs are irrelevant when we're deciding what to do with the product after the split off point okay before the split-off point when we're just deciding hey do we even want to be operating this dairy farm is this even profitable okay we can we can make that decision then right we can before the split-off point all at this point here that's when we care about those costs but now that we're now that we're actually we've proc we we've got the products they're uniquely separable they're sit we got the whole milk sitting there we got the cream sitting there we've already incurred The Joint cost right that's all so this 250,000 isn't relevant after the split-off point when we're deciding whether or not to process the the the milk or the cream further what we really want to do is just look at the incremental cost and benefits of doing so so we just want to say okay look at this point it would be 55,000 extra to turn that whole milk into non-fat milk right and we would get an extra $60,000 in revenue for doing so so we get five grand profit out of doing that we don't care at this point what the joint costs were or whatever those costs have already been incurred and so they're not relevant to us after the split-off point