Cost Accounting (14th Edition)

410 CHAPTER 11 DECISION MAKING AND RELEVANT INFORMATION
Exhibit 11-10
Relevant-Revenue and Relevant-Cost Analysis for Closing Allied West
and Opening Allied South
(Incremental
Loss in Revenues)
and Incremental Incremental Revenues and
Savings in Costs
(Incremental Costs)
from Closing
from Opening
Allied West
Allied South
(1) (2)
Revenues $(1,200,000) $1,200,000
Cost of goods sold 920,000 (920,000)
Furniture-handling labor 92,000 (92,000)
Furniture-handling equipment cost
written off as depreciation 0 (25,000)
Rent 36,000 (36,000)
Marketing support 30,000 (30,000)
Sales-order and delivery processing 32,000 (32,000)
General administration 48,000 (48,000)
Corporate-office costs 0 0
Total costs 1,158,000 (1,183,000)
Effect on operating income (loss) $ (42,000) $ 17,000
Should Allied Furniture open Allied South? Exhibit 11-10, column 2, indicates that it
should do so 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 should be ignored. Total corporateoffice
costs will not change if Allied South is opened, therefore these costs are irrelevant.
Learning
Objective 6
Explain why book value
of equipment is
irrelevant in equipmentreplacement
decisions
. . . it is a past cost
Irrelevance of Past Costs and Equipment-
Replacement Decisions
At several points in this chapter, when discussing the concept of relevance, we reasoned
that past (historical or sunk) costs are irrelevant to decision making. That’s because a
decision cannot change something that has already happened. We now apply this concept
to decisions about replacing equipment. We stress the idea that book value—original cost
minus accumulated depreciation—of existing equipment is a past cost that is irrelevant.
Example 6: Toledo Company, a manufacturer of aircraft components, is considering
replacing a metal-cutting machine with a newer model. The new
machine is more efficient than the old machine, but it has a shorter life.
Revenues from aircraft parts ($1.1 million per year) will be unaffected by the
replacement decision. Here are the data the management accountant prepares
for the existing (old) machine and the replacement (new) machine:
Old Machine New Machine
Original cost $1,000,000 $600,000
Useful life 5 years 2 years
Current age 3 years 0 years
Remaining useful life 2 years 2 years
Accumulated depreciation $600,000 Not acquired yet
Book value $400,000 Not acquired yet
Current disposal value (in cash) $40,000 Not acquired yet
Terminal disposal value (in cash 2 years from now) $0 $0
Annual operating costs (maintenance, energy, repairs,
coolants, and so on) $800,000 $460,000