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Transcript of Discontinuation Of
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DISCONTINUATION
OF
PRODUCT LINEPRESENTED TO:-DR MEERU SEHGALPRESENTED BY:-
CHIRANSH GOYAL
ROLL NO- 8118
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If the products are making a contribution towards fixed cost or inother words if selling price is more than variable cost , it is preferablenot to close down the business . This will help in reducing the losses
which otherwise be more if the business is shut down.
If the business closed down there may be certain fixed costswhich could be avoided but there will be certain expenses which
will have to be incurred at the time of closing the operations
like redundancy payments , necessary maintenance of plant or
overhauling of plant on reopening , training of personnel etc.
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Such costs are associated with closing down of the business and
must be taken into consideration before taking any decision .
Fixed costs may be general or specific .General fixed costs may ormay not remain constant while specific costs will be directlyaffected by the closing down of the operation .To conclude , if general fixed costs are likely to come down inthe event of closure or suspension of activities , the excess of
contribution over specific fixed costs will have to be compared
with reduction in general fixed costs . If the former exceeds the
latter it is profitable to continue the activities and close down
or suspend activities if the latter exceeds the former .
In addition to cost consideration , there may be some non-costconsiderations which may weigh in taking the decision toclose down or suspend its activities or not . The following
non- cost considerations are :
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Once the business is closed down , competitors may establish theirproducts and our business may be lost . It may be difficult torecapture the lost market again ; heavy advertisement charges may
have to be incurred to recapture the business again .
Fear of retrenchment of workers . If workers are discharged itmay be difficult to get experienced and skilled workers again at
restart of the business .
Plant may become obsolete with the closure of the business andheavy capital expenditure may have to be incurred on restart of thebusiness .
Reputation of the firm may suffer if some activities are closeddown or suspended .
Temporary closing down or suspending activities may not be
desirable if the relationship with the suppliers is adversely affectedFear of non-collection of dues from customers in case of business
may not go in favour of closure of business.
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Problem 1 :
Mermaid & Co. manufactures perfumes Exalt , Confident and
Beala with installed capacity of 15000 units of exalt , 25000 units
of confident and 35000 units of beala per month . The finance
manager of the company has given the following data of
performance for August :
TABLE 1
Production PlanExalt Confide
ntBeala
No. of units produced and
soldRs.
15000 25000 35000
Sales price per unitRs.
12 10 11
Sales volume A
Rs.
180000 250000 385000
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Labour and other variablecostsRs.
60000 75000 70000
Fixed OHRs. 45000 100000 140000
Total costs BRs.
180000 275000 315000
Profit / Loss
Rs.
_ - 25000 70000
Aggregate profit An institutional director , who saw the report , recommended for
the discontinuance of Confident as it has incurred a loss of Rs.
25,000 . The company s market is saturated . What would be
your view ?
The contention of the institutional director is based on the
report , which is on absorption costing basis . For decision-making
, the relevant is marginal costing . Should the operational data be
in marginal costing pattern , it would have given an entirelydifferent picture as under.
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TABLE -2Cost sheet under marginal costing
Exalt Confident Beala
No. of units producedand sold Rs. 15000 25000 35000
Sales price per unit Rs. 12 10 11
Sales volume A Rs. 180000 250000 385000
Material cost Rs. 75000 100000 105000
Labour and other variablecosts
Rs. 60000 75000 70000
Total variable cost - B Rs. 135000 175000 175000
Contribution [ A-B ] Rs. 45000 75000 210000
Total contribution 330000
Less: Fixed overheads (285000)
Profit 45000
It may be observed that Confident had made a contribution of Rs.
75,000 . If it were to be discontinued , the overall performance of the
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company would result in a loss of Rs. 30,000 , as against the profit
of Rs. 45,000 with Confident . This could be seen in table 3 .
TABLE 3
Cost sheet if Confident is discontinued
Exalt Beala
No. of units produced and sold
Sales price per unitSales volume A
Material cost
Labour and other variable costs
Total variable cost B
Contribution ( A-B)
Total contribution
Less : Fixed overheads
Loss
15,000
Rs. 12Rs.1,80,000
Rs. 75,000
Rs.60,000
Rs.1,35,000
Rs. 45000
35,000
Rs. 113,85,000
1,05,000
70,000
1,75,000
2,10,000
255000
285000
(30,000
)Conclusion is that the unit should continue producing Confident
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Problem2 : The Sky Rock Ltd Produces and sells three types of
products P, Q and R. The management committee has decided to
discontinue the production of Q since there is not much profit in
it . From the following set of information , find out the profitabilityof the products and give your short comments on the decision of
the management .
Sellingprice perunit
Directmaterialper unit
Direct wages per unit
Dept. A Dept. B Dept. C
P
Q
R
Rs. 300
Rs. 275
Rs. 305
Rs. 60 Rs. 20 Rs. 15 Rs. 10
Rs. 30 Rs. 20 Rs. 20 Rs. 10
Rs. 70 Rs. 12 Rs. 10 Rs. 20
The absorption rates of overhead on direct wages are :
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Dept. A Dept. B Dept. C
Variable overhead 150% 120% 200%
Fixed overhead 200% 240% 150%
Solution
Statement Showing Comparative Profitability of Products P,Q and R
P Rs. Q Rs. R Rs
Selling price per unit 300 275 305Less: Variable cost :Direct material 60 30 70Direct wages : Dept. A 20 20 12
Dept. B 15 20 10Dept. C 10 10 20
Variable overhead :Dept. A ( 150% of direct wages ) 30 30 18Dept. B ( 120% of direct wages ) 18 24 12
Dept. C ( 150% of direct wages ) 20 173 20 154 40 182Contribution 127 121 123
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Less : Fixed cost : 40 40 24Dept. A ( 200% of direct wages ) 36 48 24Dept. B ( 240% of direct wages ) 15 15 30
91 103 78
Profit 36 18 45
P/ V Ratio : Contribution x 100 127 x 100 121 x 100 123 x 100
Sales 300 275 305
42.33% 44% 40.33%
Comments : The management has taken a view to discontinueproduct Q based on unitary profit . This is a wrong decision . This
decision should be based on P/V Ratio, which is highest in product
Q . Management should explore the possibility of increasing theproduction of product Q , because this step will increase the total
profit of the company owing to better P/V Ratio of product Q . By
discontinuing product Q , its share of fixed cost will be borne by
product P and R and thus total profit of company will reduce .
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Problem 3 : A company is engaged in 3 distinct lines of production.
Their production cost per unit and selling prices are as under :
A B CProduction ( units ) 3,000 2,000 5,000
Rs. Rs. Rs.Material cost 18 26 30
Wages 7 9 10Variable overheads 2 3 3Fixed overheads 5 8 9
32 46 52Selling price 40 60 61
8 14 9
The management wants to discontinue one line and gives you theassurance that production in two other lines , shall rise by 50% .
They intend to discontinue the line which produces article A as it
is less profitable .
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ii. Offer your comments and show the necessary statements to
support your decision .
i. Do you agree to the scheme in principle ? If so , do you think
the line which produces A should be discontinued .
Solution :Statement Showing Comparative Profitability
Products
A3000Rs.
B2000Rs.
C5000Rs.
Total
Rs.
Units
Sales 120000 120000 305000 545000Less: Variable cost 81000 76000 215000 372000
Contribution 39000 44000 90000 173000Less: Fixed cost 15000 16000 45000 76000
Profit 24000 28000 45000 97000
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If A is given up , sale of B and C will increase by 50%
Contribution on B = 3000 x 22 = 66,000
Contribution on C = 7500 x 18 = 1,35,000
2,10,000
Less: Fixed cost 76,000
Profit 1,25,000
If B is given up , sale of A and C will increase by 50%Contribution on A = 4500 x 13 = 58,500
Contribution on C = 7500 x 18 = 1,35,000
1,93,500Less: Fixed cost 76,000
Profit 1,17,500
If C is given up , sale of A and B will increase by 50%Contribution on A = 4500 x 13 = 58,500
Contribution on B = 3000 x 22 = 66,000
Less: Fixed cost 76,000
1,24,500
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Profit 48,500
When A is given up , the profit is maximum . The management
decision to give up A is profitable . The decision to give up a
product is to be guided by its contribution . The investment
opportunity paying the highest contribution will be preferred .
Problem 4 : The Skyrock Ltd. produces and sells three types of
products P, Q and R . The management committee has decided to
discontinue the production of Q since there is not much profit in it. From the following set of information find out the profitability of
the products and give your short comments on the decision of the
management . (Rs.)
Selling priceper unit
Direct materialper unit
Direct wages per unitDept. A Dept. B Dept.C
P
Q
R
300
275
305
60
30
70
20 15 10
20 20 10
12 10 20
Th b i f h d di
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The absorption rates of overhead on direct wages are :
Dept. A Dept. B Dept. C
Variable overhead
Fixed overhead
150%
200%
120%
240%
200%
150%
Solution :
Profitability statement of Skyrock Ltd.Particulars P Q R
1. Selling price per unit
2. Direct material
3. Direct wages : Dept. A
Dept. B
Dept. C
4. Prime cost ( 2 +3)
5. Variable overhead
Dept. A ( 150% of D.wages)
300
60
20
15
10
105
30
18
275
30
20
20
10
80
30
24
305
70
12
10
20
112
18
12
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Dept. C ( 200% of D.
wages)
Total
6. Total variable cost ( 4+5)
7. Contribution (1- 6)
8. Fixed cost
Dept. A ( 200% of D.wages)
Dept. B ( 240% of D.wages)
Dept. C ( 150% of D.
wages)Total
9. Profit (7- 8)
10. P.V. ratio Contribution x 100
Sales
20
68
173
127
40
36
15
91
36
42%
20
74
154
121
40
48
15
103
18
44%
40
70
182
123
24
24
30
78
45
40%
Comments :
The management has taken a view to discontinue product Q based
on unitary profit . This decision should be based on P.V. ratio, which
is highest in product Q . Management should explore the possibility
of increasing the production of product Q , because this step will
i h l fi f h i b P V i
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increase the total profit of the company owing to better P.V. ratio
of product Q . By discontinuing product Q its share of fixed cost
will be borne by products P and R and thus total profit of company
will reduce .