Question

Task

Purpose: To enable students in identifying relevant costs and benefits from those that are irrelevant pertaining decisions / alternatives from which the alternative with the greatest net benefit may be chosen in aiding decisions making.

Requirement: Short term decision making

BeBright Co., a wholesaler, sells its products to retailers throughout Kuala Lumpur. The company has adopted a regional structure with each region consisting of 2 sales territories. Each region has its own regional office and a warehouse which distributes the goods directly to the customer. Each sales territory also has an office where the sales and marketing staffs are located. In the Cheras region as well there are 2 sales territories with offices located in Connaught Gardens and Midah Gardens. The budgeted results for the next 3 months are as follows: -

                                                                                                Connaught          Midah                   Total     
                                                                                                (RM000s)             (RM000s)             (RM000s)            
Cost of goods sold                                                           1,600                     1,000                     2,600

Marketing / salespersons’ salaries                              300                         240                         540

Sales office rent                                                                                  150                         120                         270

Depreciation of sales office equipment                      50                           40                           90

Allocation of warehouse rent                                          48                           24                           72

Depreciation of warehouse equipment                      38                           22                           60

Regional & headquarter’s costs:
Avoidable costs                                                                    272                    186                             458

Unavoidable costs                                                              760                         340                      1,100                    
Total costs assigned to each location                       3,218                     1,972                     5,190

Reported profit / (loss)                                                     382                     (272)                        110                     
Sales                                                                                      3,600                     1,700                     5,300                    

The company is evaluating whether it should discontinue Midah Gardens sales office as it is not profitable. Assuming that the above results are likely to be typical of future quarterly performance, should the company discontinue this sales territory?

Required:

State which of the above costs are relevant and irrelevant. Why?                                       

Analyse the relevant costs related to keeping or discontinuing the Midah Gardens sales office. What should the company do (keep or discontinue Midah Gardens)?                                   

What are TWO (2) qualitative factors that the company should consider in making its final decision?                                                                                                                                                   

Answer 1

a. Costs that would continue regardless of whether Midah Gardens sales office is discontinued or not are not relevant. Costs that can be avoided are relevant, i.e those costs which would not be incurred if the office is closed down. Depreciation on equipment is an allocation of sunk cost, and hence would not be relevant to decision making.

Cost of Midah Gardens sales office	Relevant	Not Relevant
Cost of Goods Sold	$ 1,000
Marketing or Salesperson's Salaries	240
Sales Office Rent	120
Depreciation on Sales Office Equipment		40
Allocation of Warehouse Rent		24
Depreciation of Warehouse Equipment		22
Other Avoidable Costs	186
Unavoidable Costs		340
Totals	$ 1,546	$ 426

2. If the office was discontinued, Sales Lost : $ 1,700

Costs that can be avoided : $ 1,546.

Therefore, there is a net disadvantage of $ 1,700 - $ 1,546 = $ 154 if the Midah Gardens office is discontinued.Therefore, the company should keep the Midah Gardens office.

3. Two qualitative factors:

a. The company would need to lay off employees working for Midah Gardens, if it was decided to be discontinued. That would affect the morale and the motivational level of the remaining employees.

b. The company would also lose its loyal band of customers. Closing down one of the offices may affect the preferences of customers of other regions too.