12.6.3: Relevant-Revenue and Relevant-Cost Analysis of Closing or Adding Branch Offices or Business Divisions

Relevant-Revenue and Relevant-Cost Analysis of Closing or Adding Branch Offices or Business Divisions

Companies periodically confront decisions about closing or adding branch offices or business divisions. For example, given Allied West’s expected annual loss of $7,000 (see Exhibit 12-8), should Allied Furniture close Allied West? Closing Allied West will save all Allied West’s costs, but there is no disposal value for Allied West’s equipment and no alternative use for its space. Closing Allied West will have no effect on total corporate-office costs.

Exhibit 12-10, column 1, presents the relevant-revenue and relevant-cost analysis using data from the “Total” column in Exhibit 12-8. The revenue losses of $1,200,000 will exceed the cost savings of $1,158,000, and decrease operating income by $42,000. Allied West should not be closed. The key reasons are that closing Allied West will not save depreciation cost or actual total corporate-office costs. Depreciation cost is past or sunk because it represents the cost of equipment that Allied West has already purchased. The $24,000 of corporate-office costs no longer allocated to Allied West will be allocated to other sales offices, but the total amount of these costs will not decline and so are irrelevant.

Table shows the relevant-revenue and relevant-cost analysis for closing Allied West and opening Allied South.

The details of the table are as follows:

A. Incremental loss in revenues and incremental savings in costs from closing Allied West

• Revenues: $1,200,000 within parentheses

• Cost of goods sold: $920,000

• Furniture-handling labor: $92,000

• Furniture-handling equipment cost written off as depreciation: $0

• Rent: $36,000

• Marketing support: $30,000

• Sales order and delivery processing: $32,000

• General administration: $48,000

• Corporate-office costs: $0

• Total costs: $1,158,000

• Effect on operating income which is a loss of $42,000 within parentheses

B. Incremental revenues and incremental costs from opening Allied South

• Revenues: $1,200,000

• Cost of goods sold: $920,000 within parentheses

• Furniture-handling labor: $92,000 within parentheses

• Furniture-handling equipment cost written off as depreciation: $25,000 within parentheses

• Rent: $36,000 within parentheses

• Marketing support: $30,000 within parentheses

• Sales order and delivery processing: $32,000 within parentheses

• General administration: $48,000 within parentheses

• Corporate-office costs: $0

• Total costs: $1,183,000 within parentheses

• Effect on operating income which is a loss of $17,000

Finally suppose Allied Furniture has the opportunity to open another sales office, Allied South, whose revenues and costs are identical to Allied West’s costs, including a cost of $25,000 to acquire furniture-handling equipment with a 1-year useful life and zero disposal value. Opening this office will have no effect on total corporate-office costs. Should Allied Furniture’s managers open Allied South? Exhibit 12-10, column 2, indicates that they should because opening Allied South will increase operating income by $17,000. As before, the cost of new equipment to be purchased in the future (and written off as depreciation) is relevant and allocated corporate-office costs are irrelevant because total corporate-office costs will not change if Allied South is opened.

Try It! 12-4

Sloan Corporation runs two stores, one in Medfield and one in Oakland. Operating income for each store in 2020 is as follows:

The table depicts revenues, operating costs, and operating income or loss for stores in Medfield and Oakland. The details of the table are as follows:

1. Revenues

Medfield: 2,200,000 dollars
Oakland: 1,600,000 dollars

2. Operating costs, cost of goods sold

Medfield: 1,400,000 dollars
Oakland: 1,230,000 dollars

3. Operating costs, variable operating costs (labor, utilities)

Medfield: 210,000 dollars
Oakland: 120,000 dollars

4. Operating costs, lease rent (renewable each year)

Medfield: 152,000 dollars
Oakland: 165,000 dollars

5. Operating costs, depreciation of equipment

Medfield: 47,000 dollars
Oakland: 42,000 dollars

6. Operating costs, allocated corporate overhead

Medfield: 89,000 dollars
Oakland: 80,000 dollars

7. Total operating costs

Medfield: 1,898,000 dollars
Oakland: 1,637,000 dollars

8. Operating income or loss

Medfield: 302,000 dollars income
Oakland: 37,000 dollars loss

The equipment has zero disposal value.

By closing down the Oakland store, Sloan can reduce overall corporate overhead costs by $90,000. Should Sloan Corporation close down the Oakland store?
Instead of closing down the Oakland store, Sloan Corporation is thinking of opening another store with revenues and costs identical to the Oakland store (including a cost of $42,000 to acquire equipment with a 1-year useful life and zero disposal value). Opening this store will increase corporate overhead costs by $9,000. Should Sloan Corporation open another store like the Oakland store? Explain.

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