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One of my friend got this question in his ACCA PM Exam:
Question is regarding Relevant Costing shut down decision of a Division by Company.
Heads such as Revenue, Cost of Sales, Selling and administrative expenses names were mentioned already and the student has to type the relevant amount in the cell plus he has to write explanation for it as well.
So what would be the treatment of :
If the co going to be shut down the Revenue lost Will incur, So what would be the explanation of lost revenue ?? Is is Incremental cost or opportunity cost ?Secondly the cost of sales will not incur anymore so will be considered as cost saving so what will be the explanation of cost saving this will be called incremental cost or Incremental Revenue or Opportunity cost ??
Please Explain it, that incremental revenue is something we can write in explanation or not ?
Because I had heard only incremental cost is Relevant not sure about incremental revenue.Thanks
When a company decides to shut down, the revenue lost is considered an opportunity cost. This is because the company is forgoing the potential revenue that it would have earned if it continued its operations. Opportunity cost refers to the value of the next best alternative that is forgone when a decision is made.
The cost of sales that will no longer be incurred when the company shuts down is considered a cost saving. This is because the company will no longer have to spend money on producing and selling the product. Cost savings are incremental costs that are relevant to the decision-making process.
It is important to note that while incremental cost is commonly discussed in the context of relevant costing, incremental revenue can also be relevant. In the case of a shutdown decision, the lost revenue can be considered as an incremental revenue that is relevant to the decision. Therefore, you can include incremental revenue in your explanation as a relevant factor to consider when evaluating the financial impact of shutting down the division.
Thanks for your response,
But I still have a question that Revenue lost is opportunity cost and we can write in explanation that it is opportunity cost. but how it can be incremental revenue ? Because there is nothing that is incremental to revenue.And How cost saving can be incremental cost ?
Because cost will not incur if we shut down a division, so how can it be called as incremental cost ?I would advise you to watch our videos on this area.
Revenue from the existing business is $40,000 per year. We are told that if Mrs Clip advertised her move to the town centre premises in the papers only, then revenue would increase by 40%, but if the move was advertised in both the papers and on the radio, then revenue would increase by 45% rather than 40%.
The existing revenue of $40,000 is not incremental. This is the level of revenue that has been earned by the business in the past and will be earned in the future whether or not a move to the town centre premises is made. It is not dependent on the decision being made. In order to get the relevant cash flow, what is required is the incremental revenue – ie the extra revenue that will be earned if the move is made. Thus if the advertising is only in the papers, then the incremental revenue earned will be 40% x $40,000 = $16,000. If the advertising is in both the papers and on the radio, then the incremental revenue will be 45% x $40,000 = $18,000.
An incremental cost is explained in the above article
Thank you
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