ACCA SBL Syllabus G. Finance In Planning And Decision-Making - Close or Continue - Notes 11 / 11
Closure or continuation decisions
Here you need to look at:
The loss in revenue from closing down the operation, and
The saving in costs from closing down (= avoidable costs).
This basically means look at its contribution - so make sure all the costs are direct - otherwise they wont be saved
Illustration
The management of Oh no It's all going wrong!
Co is considering the closure of one of its operations (department 2) and the financial accountant has submitted the following report.
| Department | 1 | 2 | 3 | Total |
| Sales (units) | 10,000 | 5,000 | 15,000 | 30,000 |
| Sales ($) | 150,000 | 92,000 | 158,000 | 400,000 |
| Direct material | 75,000 | 75,000 | 50,000 | 200,000 |
| Direct labour | 25,000 | 25,000 | 10,000 | 60,000 |
| Production overhead | 5,000 | 2,500 | 7,500 | 15,000 |
| Gross profit | 45,000 | -10,500 | 90,500 | 125,000 |
| Expenses | -15,000 | -9,200 | -15,800 | -40,000 |
| Net profit ($) | 30,000 | -19,700 | 74,700 | 85,000 |
In addition to the information supplied above, you are told that:
Production overheads of $15,000 have been apportioned to the three departments on the basis of unit sales volume
Expenses are head office overhead, apportioned to departments on sales value.
As management accountant, you further ascertain that, on a cost driver basis:
Half of the so-called direct labour is fixed and cannot be readily allocated.
Prepare a report for management including a restatement of the financial position in terms of contribution made by each department and making a clear recommendation.
| 1 | 2 | 3 | Total | |
|---|---|---|---|---|
| Sales | 150,000 | 92,000 | 158,000 | 400,000 |
| Direct Materials | (75,000) | (75,000) | (50,000) | (200,000) |
| Direct Labour | (12,500) | (12,500) | (5,000) | (30,000) |
| Production Overheads | (5,000) | (2,500) | (7,500) | (15,000) |
| Contribution | 57,500 | 2,000 | 95,500 | 155,000 |
As Department 2 makes a positive contribution it should not be closed down
Shut down decisions
Loss of contribution from the segment
Savings in specific fixed costs from closure
Penalties resulting from the closure, e.g. redundancy, compensation to customers
Alternative use for resources released
Knock-on impact, e.g. loss leaders cancelled - products that got customers into the store