Accounting Assignment Help With Suspension of Activities

1.10 Suspension of Activities

During trade recession and cut throat competition the demand of the product is not adequate to cover the fixed costs, management may consider to suspend the operations for the time being. If certain portion of fixed expenses is escapable e.g. salary of temporary staff then size of contribution should exceed the escapable fixed costs. In some units when production is restarted after suspension, some additional or special costs are incurred like overhauling of the plant and machinery. These costs are called additional costs of shut down. These costs are deducted from the escapable fixed costs and amount of contribution is compared with the net escapable fixed costs. If the contribution is greater than the net escapable fixed cost, the production should be continued and vice versa.

Net escapable fixed cost = Total fixed cost for the period – unescapable

fixed costs + additional costs of shut down.

Example:

XYZ Ltd. is manufacturing 200,000 boxes per annum when working at normal capacity. The cost information is as follows:

$

Direct Material 8

Direct Labour 2

Variable Overheads 3

Fixed Overheads 3

Total Cost 16

The selling price is $ 20 per unit. It is estimated that in the next quarter only 10,000 units can be produced and sold. Management plans to shut down the plant and estimating that fixed cost can be reduced to $ 80,000 for the quarter. The fixed overheads are incurred uniformly throughout the year. Additional cost of plant shut down is $ 10,000.

From the above information you are requested to decide the following:

a) Whether the plant should be shut down for a period of three month

Calculate the shut down point for three months.

Solution:

$

a) Sale Price 16

Marginal Costs : $

Direct Material 8

Direct Labour 2

Variable Overheads 3 13

Contribution: $ 3 per unit.

Fixed Overhead = $ 3 x 200,000 = $ 600,000 per annum

$ 600,000

Fixed overheads for quarter = $ 1,50,000

4

If plant is operated, the loss is : $

Total contribution on 10,000 units = 30,000

(10,000 units x $ 3)

Fixed Cost = 150,000

Loss (Fixed cost – Contribution) = 120,000

If plant is closed, then loss will be:

Unescapable fixed cost = $ 80,000

Addition shut down cost = $ 10,000

Total Loss = $ 90,000

As is evident from the above calculations that the plant should be closed down for the quarter, so that the loss will be reduced by $ 30,000.

b) Shut down point

Net Escapable Fixed Cost = Total Fixed Cost for the period – Shut down costs + additional costs.

= $ 150,000 – $ 80,000 + $ 10,000 = $ 80,000

For suspension of business activity, only costs should not be taken into consideration, there are other factors also like, employees interest, fear of plant obsolescence, loss of customers in future, government action, perishable raw material and company is having a huge stock of material, etc.

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