Sir, why we don't include not avoidable fixed costs when making a decision?
As i understand we need to calculate effect on profit and it is contribution - fixed costs.
Or this is because we are not told to do that in this particular example?
Thank you in advance!
J
John MoffatTutor·
If the fixed costs are not avoidable then they will be paid anyway. If they are being paid whatever the decision is then they are irrelevant to the decision.
A
Asif·
Great lecture, neatly explained.
J
jijo·
Sir, when we stop producing Rooks, should we still find the difference from the '5000' profit ,because it still included the loss we got by producing Rooks so when we calculate the effect of stopping the product, aren't we in a way double calculating the effect of producing/stopping Rooks?
or in other words shouldn't we only calculate the profit of the other two items and then calculate the loss of 10000 which arises due to stopping Rooks? I hope you got what I meant my English is not that good but would appreciate your help..
J
John MoffatTutor·
If they stop Rooks then they will lose the contribution of $15,000.
The fixed overheads will reduce by $5,000, and therefore the total profit will fall by $10,000 (and become a loss of $5,000).
The question does not ask for the actual profit figure - only whether or not they should stop producing Rooks.
You can either calculate the new profit and compare with the current profit, or alternatively just calculate the change in the profit as above.
A
Azka·
Thanks for the lecture.
I have this same example in my BPP Text book.
here it says: It would be more profitable to shut down production of Rooks and switch resources to making Crowners, in order to boost profits by $4000 to $9000.
Where did this $9000 come from?Will appreciate your help.
J
John MoffatTutor·
They are currently making a profit of $5,000 as per the question.
If they shut down Rooks and switch to Crowners, then the profit increases by $4,000 as I explain in the lecture (and as is printed in the lecture notes). Therefore the profit will change to $5,000 + $4,000 = $9,000.
However given the question does not ask what the profit will be but just asks whether or not they should switch, all that matters is the fact that switching will give extra profit (an extra $4,000) and therefore it is worth switching.
P
Puja·
Hi John,
For part B, why do we not need to include the variable costs for Crowners at $30,000?
Thank you
J
John MoffatTutor·
But I have brought in the variable costs!
I list the contribution from Crowners of 20,000, which is the revenue of 50,000 less the variable costs of 30,000.
T
Tan·
Hi John,
a)Change in current profit?
b) Effect on current profit?
Does the current profit refer to the Rooks's loss of (30,000)?
J
John MoffatTutor·
The current profit is the current profit of the company, which is $5,000.
If they stop producing Rooks, then this profit of $5,000 will change.
T
Tan·
Thanks John!
Appreciate your replied.
J
John MoffatTutor·
You are welcome :-)
A
alie2018·
Thanks John. Presentation well understood. If the relevant benefits of closure is greater than the relevant costs of closure then closure may occur. However, there are other factors (including qualitative factors) to be considered before making a final decision for example loss of business (custom) if we stop Rooks, reorganization costs, redundancy costs (staff dismissal), penalties (compensation to customers).
Having said that, Rooks is making a contribution of $10,000 before fixed costs of $13,000 ($18,000 - $5000) towards overall profit. This contribution would be lost if we stop production and sales of Rooks and will reduced the company's profit down by $10,000. Of course the results of Crowners will boost the company's profit if we cease selling Rooks.
So John is it in all cases that a department or product should be closed because it is simply making a loss?
J
John MoffatTutor·
You are right that in practice other factors are likely to need to be considered. However in the exam you can only make the decision based on the information given in the question (but in written parts to questions you could certainly be expected to mention other likely factors).
As i understand we need to calculate effect on profit and it is contribution - fixed costs.
Or this is because we are not told to do that in this particular example?
Thank you in advance!
or in other words shouldn't we only calculate the profit of the other two items and then calculate the loss of 10000 which arises due to stopping Rooks? I hope you got what I meant my English is not that good but would appreciate your help..
The fixed overheads will reduce by $5,000, and therefore the total profit will fall by $10,000 (and become a loss of $5,000).
The question does not ask for the actual profit figure - only whether or not they should stop producing Rooks.
You can either calculate the new profit and compare with the current profit, or alternatively just calculate the change in the profit as above.
I have this same example in my BPP Text book.
here it says: It would be more profitable to shut down production of Rooks and switch resources to making Crowners, in order to boost profits by $4000 to $9000.
Where did this $9000 come from?Will appreciate your help.
If they shut down Rooks and switch to Crowners, then the profit increases by $4,000 as I explain in the lecture (and as is printed in the lecture notes). Therefore the profit will change to $5,000 + $4,000 = $9,000.
However given the question does not ask what the profit will be but just asks whether or not they should switch, all that matters is the fact that switching will give extra profit (an extra $4,000) and therefore it is worth switching.
For part B, why do we not need to include the variable costs for Crowners at $30,000?
Thank you
I list the contribution from Crowners of 20,000, which is the revenue of 50,000 less the variable costs of 30,000.
a)Change in current profit?
b) Effect on current profit?
Does the current profit refer to the Rooks's loss of (30,000)?
If they stop producing Rooks, then this profit of $5,000 will change.
Appreciate your replied.
Having said that, Rooks is making a contribution of $10,000 before fixed costs of $13,000 ($18,000 - $5000) towards overall profit. This contribution would be lost if we stop production and sales of Rooks and will reduced the company's profit down by $10,000. Of course the results of Crowners will boost the company's profit if we cease selling Rooks.
So John is it in all cases that a department or product should be closed because it is simply making a loss?