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Chapter 25: 25-4RQ (page 1406)

What are sunk costs? Give an example.

Short Answer

Expert verified

Sunk costs are the costs incurred in the past by the business entities, and they are also consideredto be irrelevantto the decision-making process.

Step by step solution

01

Meaning of Cost

In accounting, cost refers to the amount of money spent by the business to acquire goods or services. Costs are incurred to generate revenues and flow the money out of business.

02

The meaning of sunk cost and its example

Sunk costs refer to the costs spent by the business in the past, and based on that, future activities are decided, which cannot be changed. Such costs are irrelevant to the business concerns while making a decision.

For instance, a business bought furniture for $10,000 5 years ago and deals in old furniture. Now the business is planning to buy new furniture. In the given scenario,$10,000 spent in the past is a sunk cost as the business cannot do anything to change that.

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Most popular questions from this chapter

What is target pricing? Who uses it?

What makes information irrelevant to decision making?

Refer to details about Skiable Acres from Short Exercise S25-2. Assume that Skiable Acres鈥檚 reputation has diminished and other resorts in the vicinity are charging only \(85 per lift ticket. Skiable Acres has become a price-taker and will not be able to charge more than its competitors. At the market price, Skiable Acres managers believe they will still serve 725,000 skiers and snowboarders each season.

Requirements

1. If Skiable Acres cannot reduce its costs, what profit will it earn? State your answer in dollars and as a percent of assets. Will investors be happy with the profit level?

2. Assume Skiable Acres has found ways to cut its fixed costs to \)30,000,000. What is its new target variable cost per skier/snowboarder?

What is differential analysis?

McCollum Company manufactures two products. Both products have the same sales price, and the volume of sales is equivalent. However, due to the difference in production processes, Product A has higher variable costs and Product B has higher fixed costs. Management is considering dropping Product B because that product line has an operating loss.

MCCOLLUM COMPANY

Income Statement

Month Ended June 30, 2018

Total Product A Product B

Net Sales Revenue \(150,000 \)75,000 \(75,000

Variable Costs 90,000 55,000 35,000

Contribution Margin 60,000 20,000 40,000

Fixed Costs 50,000 5,000 45,000

Operating Income/(Loss) \)10,000 \(15,000 \)(5,000)

  1. If fixed costs cannot be avoided, should McCollum drop Product B? Why or why not?
  2. If 50% of Product B鈥檚 fixed costs are avoidable, should McCollum drop Product B? Why or why not?
See all solutions

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