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Relevant cost

Pacific Tour operates tours throughout the US. Studies show that the tours are not profitable, and are considering dropping the tours to improve the company operating
performance. Below is an income statement from a tour below:

Ticket revenue 3,000 100%
(100% seat capacity*40% occupancy*
$75 ticket price per person)
Variable expenses (22.50 per person) 900 30
Contribution margin 2,100 70%

Tour expenses:
Tour promotion 600
Salary of bus driver 350
Fee, tour guide 700
Fuel for bus 125
Depreciation of bus 450
Liability insurance, bus 200
Overnight parking fee, bus 50
Room & meals, driver & t guide 175
Bus maintence & prep 300
Total tour expenses 2,950
Net operating loss (850)

Additional info about the tour:
a. Bus drivers are paid fixed annual salaries, tour guides are paid for each tour conducted
b. The bus maintence and preparation is an allocation of the salaries of mechanics and other service personnel who are responsible for keeping the company fleet of buses in good operating condition.
c. Depreciation of buses is due to obsolescence. Depreciation due to wear and tear negligible.
d. Liability issuance premiums are based on the number of buses in the company's fleet
e. Dropping the tours would not allow Pacifica to reduce the number of busses in the fleet, the number of bus drivers on the payroll, or the size of the maintenance and preparation staff.

1. Prepare an analysis showing what the impact will be on the company's profits if the tour is discontinued.
2. The company's tour director has been criticized because only about 50% of the seats on Pacific tours are being filled as compared to an industry average of 60%. The tour director has explained the company's average seat occupancy could be improved considerably by eliminating about 10% of its tours, but that doing so would reduce profits. Explain how this could happen.


Solution Summary

The solution explains the use of relevant costs in deciding to either drop or retain a tour.