Explain why one must be careful when accounting for erosion costs. Wh

Explain why one must be careful when accounting for erosion costs.

What will be an ideal response?

ANSWER

Answer: Erosion costs occur whenever a company’s new product competes against its existing products, thereby reducing the sales of these existing products. One must be careful in including the reduced sales. This is because the sales could be reduced anyhow if another company introduces a competing product. Also, if erosion reduces sales, then the costs are also reduced. In brief, one must be careful so that only the net additional revenue and costs should be included in the incremental cash flow—the increase in overall sales and costs to the company.