State university business school (subs) offers several degrees, including bachelor of business administration (bba). the new dean believes in using cost accounting information to make decisions and is reviewing a staff-developed income statement broken down by the degree offered. the dean is considering closing down the bba program because the analysis, which follows, shows a loss. tuition increases are not possible. the dean has asked for your advice. if the bba degree program is dropped, school administration costs are not expected to change, but direct costs of the program, such as operating costs, building maintenance, and classroom costs, would be saved. there will be no other changes in the operations or costs of other programs.

state university business school, bba degree
degree income statement
for the academic year ending june 30
revenue $ 6,000,000
costs
advertising—bba program 225,000
faculty salaries 3,060,000
degree operating costs (part-time staff) 390,000
building maintenance 555,000
classroom costs (building depreciation) 1,275,000
allocated school administration costs 645,000
total costs $ 6,150,000
net loss $ (150,000 )
state university business school, bbadegree

degree income statement
differential revenues costs

for academic year ending june30

revenue

costs

advertising bba program

faculty salaries

degree operating costs

building maintenance

classroom costs

allocated school administration costs

total costs

net diferenetial (loss or gain? ) how much?

required:

a. using the worksheet below, determine which revenues and costs are probably differential for the decision to drop the bba program.

b. what will be the net effect on the subs contribution (profit) if the bba program is dropped?

subs contribution (profit) will (increase or decrease? ) by how

Here we must use relevant costing for making the decision either we should continue the BBA program or we should close it down.

Now according to relevant costing principles if the cost is relevant then it must satisfy following conditions:

Clearly cash would be used here and the cost or income arising must not be linked to the past bindings, it must be future related. The third condition is very interesting here, the concept of differential can be grasped by the following table which I have derived by teaching students of Nottingham Trent University:

Step 1: What is the cash flow if we don't make decision?

Step 2: What is the cash flow if we make the decision?

Step 3: Take the difference of step one and two. The difference is differential or incremental cost.

Now from the above steps what we learned is that an incremental cost will arise if we take the decision (closing down BBA), and it will not arise if we don't take the decision (closing down BBA).

DEGREE INCOME STATEMENT (DIFFERENTIAL REVENUES COSTS)

FOR ACADEMIC YEAR ENDING JUNE30

                                                     Step 1              Step 2             Step 3

                                             Make Decision    If we Don't     Differential

Revenue loss                          (6,000,000)             -              (6,000,000)

Direct Costs Savings

Advertising BBA Program               -                 225,000         225,000

Faculty Salaries                                -               3,060,000      3,060,000

Degree Operating Costs                 -                390,000         390,000

Building maintenance                      -                555,000         555,000

Classroom Costs  W1                        -                       -                      -

All. administration costs W2      645,000         645,000               -      

TOTAL COSTS                                                                         (1,770,000)

We can see that there is no benefit arising by making this decision. The decrease in contribution is by $1,770,000. As there is no benefits arising, so closing down BBA program is not in cards.

Explanation:

Working 1 (W1): The classroom cost is basically depreciation and depreciation is a non cash flow item so it does not satisfies the conditions of being relevant cost.

Working 2 (W2): General overheads like in this case we have Allocated school administration cost, is not relevant here because, it is past binding and is also not differential or incremental. It must not be included in the computation, however I had included it because I think you must understand why it is not differential.

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