Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 18

Cost Data for Managerial Purposes

Beige Computers operates retail stores in both downtown (City) and suburban (Mall) locations The company has two responsibility centers: the City Division, which contains stores in downtown locations, and the Mall Division, which contains stores in suburban locations. Beige’s CEO is concerned about the profitability of the City Division, which has been operating at a loss for the last several years. The most recent income statement follows. The CEO has asked for your advice on shutting down the City Division’s operations. If the City Division is eliminated, corporate administration is not expected to change, nor are any other changes expected in the operations or costs of the Mall Division.

BEIGE COMPUTERS, CITY DIVISION Divisional Income Statement For the Year Ending January 31
Sales revenue	$12.900.000
Costs
Advertising—City Division	525.000
Cost of goods sold	6.450.000
Divisional administrative salaries	870.000
Selling costs (sales commissions)	1.730.000
Rent	2.215.000
Share of corporate administration	1.425.000
Total costs	$13.215.000
Net loss before income tax benefit	$(315.000)
Tax benefit at 40% rate	126.200
Net loss	$(189.000 )

Required

What revenues and costs are probably differential for the decision to discontinue City Division’s operations? What will be the effect on Beige’s profits if the division is eliminated?

Step 1 of 2

While taking decision in respect of whether to discontinue a division or not, the company needs to consider only the differential costs and differential revenues. The company should consider only those differential costs and revenues in the decision making process. These are the costs and revenues that change in response to particular course of action.

In the present case, B Computers is thinking of discontinuing one of its divisions called City division because of the operating loss of the division. In such a case, the company needs to consider only those costs that are differential. The following revenues and costs are probably differential for the decision to discontinue the city division.

Sales revenue: Sales revenue would definitely be a differential revenue item because it would change in response to particular course of action. It means, if the division is discontinued, the sales revenue of this division will be eliminated and the overall sales revenue of the company also changed.

All the costs except the share of corporate administration would definitely be differential costs because these costs will change in response to a particular course of action. These costs (Divisional advertising costs, cost of goods sold, divisional administrative salaries, selling costs and rent) except the share of corporate administration will be eliminated and would not exist if this division is discontinued.

Share of corporate administration (irrelevant cost) is not a differential cost because it is not a cost that is incurred by the division and it is just an allocation of administrative expenses of corporate.

It can be said that all costs except share of corporate administration are differential costs and sales revenue is differential revenue that are to be considered by the company while making decision in respect of discontinuation of the city division.