Processing Pillows into Deluxe Pillows: A Boost in Operating Income

How does processing pillows into deluxe pillows affect Posh Pillows' operating income?

What are the key factors to consider when deciding whether to process pillows further into deluxe pillows?

Answer:

The net profit will increase by $11,500.

Posh Pillows manufactures two products, pillows and cushions, from a joint process. Pillows are allocated $7000 of the total joint costs of $30,000. There are 2500 pillows produced and 2500 cushions produced each year. Pillows can be sold at the split-off point for $14 per unit, or they can be processed further into a deluxe pillow for additional processing costs of $8500 and sold for $18 for each deluxe pillow.

The change in net income by producing deluxe pillows is calculated as follows:

Profit from selling deluxe pillows = (Selling price - Additional costs - Split-off point sales)

= ($18 * 2,500) - $8,500 - ($14 * 2,500)

= $45,000 - $8,500 - $25,000

= $11,500

Further processing pillows into deluxe pillows will increase Posh Pillows' operating income by $11,500. The incremental revenue of $10,000 from selling the deluxe pillows exceeds the additional processing costs of $8,500, resulting in a net profit increase.