Management Accounting

Topic: Relevant costing

Question 1 Background Cafayolay Ltd operates within the hot drinks industry. Their key expertise lies in the area of roasting coffee. Until recently, management believed that it was critical for the company to manage its own marketing and distribution activities. Therefore the company has always operated a marketing and distribution division [M&D division]. However, following a significant expansion of the company and of its product range, this policy has been re- considered. Management now believe that the company should focus exclusively on roasting coffee. Consequently, the M&D division is to be shut down and arrangements have been made to outsource marketing and distribution services from a specialist company, called Marketing Ltd, at a cost of 70,000 per month. Cafaxolay Ltd must now decide when to shut down the M&D division. Marketing Ltd have indicated that they are willing to commence operating on Cafayalay Ltd's behalf either on 1 January 2009 or on 1 June 2009. Quarterly Costs of Operating the M&D Division Details of the average budgeted quarterly costs to operate this division in 2009 are as follows: Wages and salaries 150,000 Advertising and promotion 69,000 Fuel for delivery fleet 33,000 Crates 9,000 General overheads 30,000 Depreciation 12,000 303.000 Financial Data Pertaining to Closure of M&D Division The following information pertaining to the closure is also available: When the M&D division is closed, one of managers will be retained on his monthly salary of 5,500 to liaise with Marketing Ltd. All other staff will be made redundant. It is expected that redundancy payments will, on average, amount to one month's pay. In order to secure the best possible advertising rates, M&D division has tended to enter into advance contracts with advertising media. As a consequence of this, Cafaxolax Ltd is already committed to paying 12,000 for advertisement slots secured in respect of January 2009. If Marketing Ltd is requested to commence operations on 1 January 2009, they will buy these advertisement slots from Cafayalax Ltd for 9,500. The M&D division has also entered into advance contracts in respect of fuel for their delivery fleet. These contracts run until 1 May 2009. Cafaxolax Ltd will suffer a cancellation penalty of 1,000 for each month that this contract is cancelled. 40% of the general overheads are directly attributable to M&D division and will be avoided if the division is closed. 30% of the general overheads apportioned to the division will be avoided if the division is closed. The NBV of the delivery fleet at 1 January 2009 will be 276,000 and at 1 June 2009 will be 256,000. It is expected that these vehicles could be sold for 280,000 in early January 2009. The sales proceeds from the fleet, if sold in early June 2009, are estimated to be 240,000. Requirement (a) Advise Cafayalay Ltd, from a financial perspective, whether they should close the M&D division on 1 January 2009 or on 1 June 2009. 16 marks