Discontinuation Of

8/2/2019 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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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 :


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 .

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Discontinuation Of