Sunk and opportunity costs for decision-making Mrs Johnston has taken out a lease on a shop for a down payment of £5000. Additionally, the rent under the lease amounts to £5000 per annum. If the lease is cancelled, the initial payment of £5000 is forfeit. Mrs Johnston plans to use the shop for the sale of clothing, and has estimated operations for the next twelve months as follows:

(£)

(£)

Sales

115000

Less Value-added tax (VAT)

15000

Sales Less VAT

100000

Cost of goods sold

50000

Wages and wage related costs

12000

Rent including the down payment

10000

Rates, heating, lighting and insurance

13000

Audit, legal and general expenses

2000

87000

Net profit before tax

13000

In the no provision has been made for the cost of Mrs Johnston but it is estimated that one half of her time will be devoted to the business. She is undecided whether to continue with her plans, because she knows that she can sublet the shop to a friend for a monthly rent of £550 if she does not use the shop herself.

You are required to:

(a) (i) explain and identify the ‘sunk’ and `opportunity’ costs in the situation depicted above;

(ii)state what decision Mrs Johnston should make according to the information given, supporting your conclusion with a financial statement;

(b) explain the meaning and use of ‘notional’ (or `imputed’) costs and quote two supporting examples.