Fleet Ltd. Incremental Analysis

1. An incremental costing analysis

If we were to accept the proposal from Results Ltd to outsource the IT department, we would incur a cost over a three year period summing £1,120. In Year 1, if we were to outsource, we would save £1,960. In Year 2, however, we would incur a cost difference of £3,040.

The reason why we have more cost savings in year 1 versus year 2 is because we assumed that the resale of the previous IT equipment of 30,000 and the pension cost of 20,000 would be paid out immediately. Because in Year 2 we do not have one time revenues (recouping the previous IT equipment in Year 1) and no one time costs (pension cost in Year 1), we can clearly see the two options in more depth and see that the difference between the two options amounts to £3,040. In Year 3, accepting to outsource returns to better cost savings (loss of £40) because consumables by the current IT is expected to increase to 7,000 and because we expect to generate 10,000 in rent for Year 3 (difference of 3,000). The incremental 3,000 increase in year 3 is because we were able to recoup 2,000 more in rental income from the previous year and because consumable cost to the current IT has increased 1,000 from the previous year. Since 40% of the overhead is fixed, this cost of 10,800 is present in both the Do Not Outsource Option and the Accept Outsource Option. Therefore this fixed cost is irrelevant in the calculations provided.

It is worth noting that if we were looking at a period longer than 3 years, we would have a different incremental analysis cost. If we were to extend this analysis to four years and beyond, we would need to repurchase the IT equipment every three years for not outsourcing. Therefore, looking at Year 4, we would incur an extra cost of £100,000 if we were not to outsource (See figure 7). This makes the Accept to Outsource option cheaper by £99,960 just in Year 4. Year 5, 6 etc would look very close to Year 3 cost analysis.

2. The effects on reported profit

If we were to outsource the IT department, we would incur a cost difference over a three year period of £1,120 (see figure 2).

Let's take year1- If we were to assume that the costs of the IT department were under the SG&A expenses of a typical balance sheet and that an outsourced IT department would be under the same expense line, then we can conclude that the two SG&A costs are very similar (Do Not Outsource being 1,960 cheaper). Since we have one time occurring expenses (pension fund), discontinued operations (recover some IT equipment as cash) as well as extraordinary income (generated by rental fees), we notice that this pushes the Accept Outsource into the cheaper option of the two in Year 1.

Notice in Year 2, the pension expense and the disposal of the IT equipment disappear. All that is left on