Shutting Down of Factory or Segment - Cost Analysis and Decision Making

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Shutting Down of Factory
or
SegmentCost Analysis and Decision Making
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Every now and then it becomes essential for a
firm to temporarily shut down its factory or a
segment due to trade depression. This decision
concerning shut down will be based on whether
products are making a contribution towards fixed
costs or not. If the articles are making a
contribution towards fixed cost, it is not
worthwhile to shut the factory or segment to
reduce the losses. Even though the factory is
shut down, some fixed expenses could not be kept
away from, for example maintenance of plant or
refurbishing etc. so these should be considered
while making decision.
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In addition to the cost consideration, some
non-cost considerations must be considered prior
to making decision to shut down a factory or
segment. The below given points are pertinent in
this regard

1. Once the business is shut down, the competitors
   may take benefit to establish their articles and
   business of the company. It is easier said than
   done to summon up the market. Heavy advertisement
   expenses have to be incurred to summon up the
   market.

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1. Once the labourers are discharged it may be
   difficult to get knowledge and skilled workers
   again to resume the business.
2. If some segment or performances are shut down, it
   may affect the reputation of the concern.
3. Temporary shutdown may not be advisable if the
   association with the suppliers is unfavourably
   affected.
4. Fright of non-collection of dues from debtors in
   case of shutting down of business may not go in
   its good turn.

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Let us discuss an illustration to understand this
concept better
Illustration
Star ltd manufactures 30,000 units of X in a
year at its normal production capacity. The unit
cost as to variable costs and fixed costs at this
stage are 6.50 and 4 respectively. The sale
price of the X is 10. Due to trade
depression, it is likely that only 3,000 units of
X can be sold during the subsequent year. The
management plans to shut down the plant. The
fixed expenses for the subsequent year then are
likely to be decreased to 49,500. Extra costs
of plant closure are likely to cost at 18,000.
Must the plant be closed down? What is close down
point?
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Solution
Comparative Statement
Particulars Plant is Functioning Plant is Closed Down
Variable cost 3,000 units _at_ 6.50 19,500 -
Fixed Cost ( 30,000 x 4 ) 120,000 49,500
Extra Closing Down Cost - 18,000
Total Cost ( a ) 139,500 67,500
Sales ( 3,000 x 10 ) ( b ) 30,000 -
Loss ( b ) ( a ) 109,500 67,500
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Recommendation
An assessment of figures relating to two choices
figures out that loss is decreased by 42,000 if
the plant is closed down.
Calculation of Close Down Point
Shut down Total Fixed Expenses Shutdown
Expenses / Contribution Per Unit (
120,000 67,500) / ( 10 - 6.50 )
52,500 / 3.50 15,000
units
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