Relevant Information:
The relevant information is as under:
Segmented income statements appear as follows:
Product Original Strawberry Orange
Sales 65,200 85,600 102,400
Variable costs (44,000) (77,200) (80,200)
Contribution margin 21,200 8,400 22,200
Fixed costs allocated (9,400) (12,000) (14,200)
Operating profit (loss) 11,800 (3,600) 8,000
Answer:
The product not be closed because it is generating net cash flows of ($3,060), which will generate loss for the organization. The better option would be to not abandoning the manufacturing of Strawberry.
Explanation:
Relevant costing says that any savings or losses are relevant if it satisfy following three conditions:
- Is a cash flow.
- Future related (Not arising due to Past bindings).
- Differential or Incremental in nature.
Its crystal clear that any inflows and outflows that are considered would be cash in nature, not related to past events it must be arising as a consequence of taking the decision whose consequences are we considering now, I mean it must arise in future due to the decision made which are considering. The last condition is the concept of differential that lies in the heart of relevant costing and is easily understood by following the following steps:
Step 1: What are the losses or savings if we don't make decision?
Step 2: What are the losses or savings if we make the decision?
Step 3: The difference between step one and two is differential or incremental cost.
Here we learned that relevant cost arises if we take the decision (closing manufacturing of Strawberry), and it doesn't arises if we don't take the decision (not abandoning manufacturing of Strawberry).
Relevant costs associated with the decision are as under:
Step 1 Step 2 Step 3
Make Decision If we Don't Differential
Revenue loss (85,600) - (85,600)
Variable Costs Savings 77,200 - 77,200
Fixed costs Savings (W1) 5340 - 5340
Operating Profit (3,060)
Working1: Fixed costs Savings
Total Fixed costs =21400+12000+14200 = $35,600
The saving is 15% of the total fixed cost and is as under:
Fixed costs Savings = $35,600 * 15% = $5340
Note:
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