PART B (35 Marks)

The classification of costs between relevant costs and irrelevant costs is important in the context of managerial decision-making. Harmony Industries is a company that manufactures personal care products. It has three divisions: hair care, skin care and dental care. Following is an extract from the financial statements for the year ending 31 December 2019:

Hair Care

Skin Care

Dental Care

Revenue

$900 million

$600 million

$300 million

Net income/(loss)

$210 million

$100 million

($50 million)

In the board meeting summoned for review of financial statements, a director proposed that the company should dispose of the dental care division because it is losing money. The CEO argued that the board can't conclude that a segment is losing money just because it generated net loss for a period. He suggested that the company's chief financial officer should conduct a detailed analysis for presentation in the next board meeting. Being the company's management accountant, the CFO asked you to identify which of the following costs are relevant for the decision:

1. CEO's salary
2. Salaries of Dental Care workers who can be laid-off
3. Salaries of Dental Care workers who can't be laid-off
4. One-time retirement benefits to be paid to laid-off workers
5. Cost of raw materials consumed by Dental Care division
6. Annual directors' fee
7. Interest paid on loans raised for Dental Care division
8. Salary of the Dental Care chief operating officer
9. Company-wide quality certification fee
10. License fee paid for the rights to manufacture dental care products
11. Head office rent
12. Audit fee (if it does not depend on the number of divisions)

Required:

a.Briefly explain the importance of distinguishing between relevant and irrelevant costs for the purpose of decision making. Provide at least two examples of situations in which the relevant vs. irrelevant classification is useful. (5 Marks)

b.Briefly explain the concept of relevant and irrelevant costs, providing a clear and appropriate example for each concept. (6 Marks)

c.Taking into consideration the case of Harmony above, and as the company's management accountant, provide the proper classification for each of the following costs as specified by the CFO above and briefly provide your reasoning for your choice. (24 Marks)