A city operates a computer service department. The department maintains and repairs the computers of all other city departments, billing them for each job performed. The billing rates are established so as to cover the repair service’s full cost of carrying out its function. For the latest year available, the department reported the following (all amounts in millions):
Revenues from billing other departments $8.9 Less: Expenditures Wages and salaries $4.0 Supplies 2.6 Other cash expenditures 1.3 Overhead allocated from other departments 1.0 $8.9 Excess of revenues over expenditures $0.0
The allocated overhead consists mainly of city administrative costs, most of which would remain the same even if the department were to cease operations. However, it also includes $0.3 million in rent. Were the department to be eliminated, the city could move its legal department into the space now occupied by the computer repair service department. The move would save the city $0.2 million, the amount currently paid in rent by the legal department. A private corporation has offered to provide the same repair service as the computer department for $8.5 million.
1. Based on the limited data provided, should the city accept the offer from the private corporation? Comment on the relevance to this decision of the $8.9 million in total cost— the measure used to establish billing rates.
2. Suppose, instead, that the city did not allocate overhead costs, and hence total costs (and billing revenues) were only $7.9 million. Should the city accept the offer? Is the $7.9 million in unallocated costs any more relevant to this decision than the $8.9 million per the allocated statement?