 Hello and welcome to this session. This is Professor Farhad in which you would look at an exercise that deal with differential revenue and cost. This topic is covered in cost accounting, as well as the CPABEC exam section. As always, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1,800 plus accounting, auditing, tax, as well as finance and Excel tutorial. If you like my lectures, please like them and share them, subscribe to the channel, connect with me on Instagram and like my Facebook page. On farhadlectures.com, you will find additional resources to complement and supplement your accounting courses, as well as your CPA, CMA, and CFA preparation. So let's take a look at this, I would say, very simple exercise, because eventually, as you proceed more in cost accounting, you're going to have to be making more in quote complex decision than this problem here. And this is just an introduction to revenue and cost differential. Now revenue and cost differential in the real world, you make certain assumptions. You have to make certain assumptions to come up with the answer. So here they're going to give us, they're going to guide us on how to make the assumptions. But remember, if you change those assumptions, your differential revenue and cost will differ and therefore your decision in the real world will differ. So let's see what we are giving here and we'll go with those assumptions because that's all what we have to work with. Now in the real world, you have to make a judgment. And when you make a judgment, you're always, you're always subject to make a mistake because you could make the wrong assumption. And if you make the wrong assumption, guess what? You make the wrong decision. So let's take a look at this exercise to see how it all fits. State University Business School offers several degrees, including Bachelors of Business Administration, BBA. The new dean belief in using cost accounting information, I guess he must be a CPA, to make decision and is reviewing a staff developed income statement broken down by degree offered. So this is what we have here. The dean is considering closing down the program because the analysis which follows show a loss. So notice the analysis show a loss of 150. Tuition increases are not possible. So for one thing, they cannot increase tuition. Tuition, why, why can't they increase tuition? Because maybe the market is competitive. If they increase the tuition, they might lose students. Or they cannot afford to do that. The dean has asked for your advice. If the BBA degree program is dropped, school administration are not expected to change. So here are the school administration. These are not expected to change, but direct cost of the program, such as operating cost, building maintenance, classroom cost would be saved. So simply put, what we're saying is the administration cost will not change, but those will be changed. And as a result, the revenue will be changed. Now what happened? Let's compute the differential cost and revenue and find out whether this is a good or a bad decision based on this specific information. Again, you could make so many different assumptions here, but we're going to go with the assumption that we are giving. Now I'll try to work some few other assumptions. That's fine. But that's not what you are told in this problem. So what happened is you're going to go from 6 million to zero, which you're going to lose the revenue from that department. Or 6 million is a differential number, because the assumption is you're going to lose it. Now is that true now? Maybe some students, they go from business to maybe finance or economics or something else, but we are not told otherwise here. For example, they could say, you know, 40% will go into another program, then you will have to change your assumption. Or 50% will move to another program, 50% will leave the school. That's a different assumption. Here advertising, it's for the business program. Well, this is going to go down to zero. So here we're going to have a savings of 225. Here we're going to have a lot. Basically, the 6 million is a lost revenue. This is a lost revenue. Here we save. On the expenses, if we remove them, we save. Faculty salaries, they're not needed, because this is part of operating the program. So they are differential degree operating costs. For those part-time people, we're going to let them go. We're not going to have anything to worry about. That's also a differential cost, which is the savings. Building maintenance, again, operating the program. They said it's going to go away. Any building operating the buildings, depreciation, the same concept. Although depreciation is not a cash flow, but again, here we are just following strictly what we are told. Allocated school administration, those will not change because those are allocated. Now, if you don't know what allocated is, we'll talk later on in future chapters. Those costs are basically they don't belong to any particular school. They belong to any particular school within the school. They don't belong to the business school, but they belong to the whole university. And what we do is we allocate. So we allocate some to the business school, some to the medical school, some to the engineering school. So if we close the business program, those will be allocated somewhere else. So they're not, it doesn't make a difference. Now we need to compute revenue minus expenses, ignoring this differential cost. Well, what happened if we compute revenue minus expenses, assuming the only thing that we can eliminate is administrative cost? We find out that we are at a profit of 4.95. So should you close the school? And the answer is no. Why not? Because by closing the school, what happens is you lost revenue more than you save and expenses. Okay? You lost revenue. This is strictly based on numbers. Now you could have other factors, other factors. For example, the reputation of the school. Maybe this year we don't have enough enrollment. Maybe in future year we will. So there are other factors, but strictly on accounting numbers, you should not close the school. Because if you were only dealing with the business school itself, we are making a profit of 4.95. In addition to that, as I just mentioned a minute earlier, that really depreciation is not cash. We are deducting 1,275,000. And we really don't pay the depreciation in cash. That's part of our capital assets, part of our fixed asset. It's just get depreciated. So simply put, based on these figures, no, you would recommendation based on what you know when accounting, we are better off keeping the business school. Although it's showing in quote a loss, but it's not really a loss. The reason it's showing a loss because of this allocated number. And also what we are assuming here that we're going to be able to remove all these expenses, we may or may not. So here we are making very extreme assumptions. But the point is by making those extreme assumptions, you will understand the decision making process. For example, if we can keep half of the revenue, that's even better. But here we are assuming we're going to lose all the revenue. We're going to lose all the expenses just to make the case. Therefore, the recommendation is we don't close. We don't close. As always, I'm going to invite you to like this recording. Visit farhatlectures.com. And we're going to be talking more about this differential cost and revenue because we're going to be talking later on in future chapters about relevant cost. Which cost is relevant? Which cost is irrelevant? Common cost and other methods that are covered in much, much more in details in future chapters, but about this particular topic. As always, stay safe. Good luck in study.