Question

The Architect Firm of Mike is examining its client base to determine how profitable its regular clients are. Its analysis indicates that Charlie, Inc. paid $160,000 in fees last year, but cost the firm $181,900 ($132,800 in billable labor, supplies, and copying, and $49,100 in allocated common fixed costs). If Mike dropped Charlie, Inc. as a client, and all fixed costs are unavoidable, how would profit be affected?

Answer 1

The Cost Incurred can be split into Variable Cost and Fixed Costs.

Variable Costs are those expenses which are incurred only if some activity is done or some goods are produced. For example, labour per unit of Product X is a variable cost.

Fixed Costs are those Costs which cannot be avoided by the firm, these costs are incurred ireespective of the production or functioning of the company.

Coming to this problem, The Client Charlie Inc is paying the firm $ 160,000

The firm incurs Variable Costs $132,800 and Fixed Cost allocation made is $49,100

The Total Costs amount to $ 181,900

Out of this, only Variable Cost is avoidable.

Hence, if the firm drops Charlie Inc as a client, it can reduce the costs upto $ 132,800

The Revenue loss would be $ 160,000.

Hence, there will be a decrease in the profit amounting to $27,200 (160,000-132,800)

Note : The Fixed Costs amounting to $ 49,100 cannot be avoided and would be allocated among other clients of the firm.