Shutdown or Continue Decision: Reason, Example

Content of Shutdown or Continue Decision

1. Shutdown decision
2. What is shut down point?
3. Reasons for shutdown production
4. Shutdown or Continue Decision Rule with example
   4.1 Short Run and Long run
5. Example & Numerical of shutdown or continue decision
6. Cases in which business is not considered discontinued
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1. What Is Shut down Decision?

A shut-down decision means that the company is stopping production for a short period. It means that the firm will resume its production in future.

The shutdown decision depends on Shut Down Point. The shutdown point denotes the exact moment when a company’s revenue is equal to its variable costs.

2. What is Shut Down Point?

A Shutdown point is a position of operation at which a company is receiving no advantage for continuing operations Thus, decides to shut down temporarily or in some cases permanently.

The shutdown point denotes the exact moment when a company’s revenue is equal to its variable costs. Variable costs such as wages, production supplies, etc.

It results from the combination of output and price where the company earns just enough revenue to cover its total variable costs.

3. Reasons of shut down production

1. Fall in demand
2. Financial problem
3. Change in technology
4. High rate of taxes
5. Inadequate availability of raw material
6. Recession in market
7. Mismanagement

4. Shutdown or Continue Decision Rule with example

Generally, For the continuation of the business, all the firms should have more revenue than total cost (REVENUE > TOTAL COST)

But In short-run all firms ignore the fixed cost hence the requirement for the short-run is REVENUE is equal to or higher than VARIABLE COST

1. Short run rule for shutdown or continue decision with example

In the short-run shutdown, we only consider the variable cost. Short-run is for a limited period of time like quarterly, half-yearly, or yearly depending upon the company.

It means we check whether the company is able to cover or not the variable cost for the short period of its sales. If not, the Firm needs to shut down.

For example: If the revenue of a company is Rs. 100 and its variable cost is Rs. 80. then the contribution will be Rs 20. In this, there is no need to shut down the product. but if the variable cost is greater than the sales, then the company has to shut down that product.

2. Long-run rule for Shutdown with example

The Long Run period is basically the future of the company. The long run can be yearly or more than yearly depending upon the type of company.

In the long run shutdown, we consider total cost i.e. fixed cost and variable cost. For example: If the sale of a company is Rs. 100 and its variable cost is Rs. 80 and fixed cost is Rs. 40. Then there is a loss of Rs. 20.

It means that the company will not survive in the long run but still can survive in the short run.

5. Example of Shutdown or Continue Decision: Numerical

QUESTION:

ABC company has fewer sales & profits so they want to shut down their product in the following cases:

• First Case: When a company wants to shut down one product.
• Second Case: When a company wants to shut down two product combinations.
• Third Case: Should the company need to shut down or continue its operation?

Particulars	Product A	Product B	Product C
Sale	₹1,10,000	₹1,50,000	₹90,000
Units of Production	9000	17000	5000
Material Cost	₹3 per unit	₹3 per unit	₹2 per unit
Labour Cost	₹1 per unit	₹1.5/Unit	₹2 per unit
Fixed Cost	Rs. 70,000	Rs. 70,000	₹70,000

Case 1: If a Company Wants to Shut Down One Product

ANSWER: For the solution, we first need to find the P&L of individual products to close down.

Variable Cost- Material Cost+Labour Cost= 4*Unit of Production
= 4*9000= ₹36000

Particulars	A	B	C
Sales	₹1,10,000	₹1,50,000	₹88,000
(-)Variable Cost	(₹36,000)	(₹76,500)	(₹20,000)
=Contribution	=₹74,000	=₹73,500	=₹68,000
(-)Fixed Cost	(₹70,000)	(₹70,000)	(₹70,000)
(=)Profit/loss	₹4,000	₹3,500	₹(2,000)

A firm should shut down the C product as it is suffering from high losses and other products i.e A AND B Products Should continue.

Case 2: If Company Wants to Shut Down Two Products (Where Firms Making Products in Combination)

In this firm is making products in combination, if a firm wants to close down the combination of one product which should be closed and continue?

When a firm wants to close down two products or one combination, we need to accumulate their sales, cost & P&L.

Particulars	A-B PRODUCT	B-C PRODUCT	A-C PRODUCT
Sales	₹2,60,000	₹240000	₹2,00,000
(-)Variable Cost	(₹1,12,500)	(₹96500)	(₹56,000)
=Contribution	₹1,47,500	₹143500	₹1,44,000
(-)Fixed Cost	(₹1,40,000)	(₹140000)	(₹1,40,000)
Profit/Loss	₹7,500	₹3500	₹4,000

Conclusion- In this solution, we can see that the B-C combination has suffered from less profit, and the A-B combination has a higher profit.

The firm can close down the B-C combination and should continue with the A-B product combination.

Case 3: Should Company Shut Down or Continue Its Operation?

Particulars	Amount (A+B+C)
Total Sales	₹3,50,000
(-)Variable Cost	(₹1,32,500)
=Contribution	₹2,17,500
(-)Fixed Cost	(₹2,10,000)
=Profit/Loss	₹7,500

Conclusion – In this, the Firm can cover all the total cost and profit from it. So the firm will continue its operation.

Reason for a fixed cost- Fixed costs will arise even if they have no production. Each product has separate 70k expenses and in total, it will be 2,10,000.

Still, have a doubt?- Comment Down

6. Cases in which business is not considered discontinued

1. Where a part of the business (unit, department, or activity) is discontinued or the business continues with the reduced activity level. It is not the discontinuation of business.
2. Where the business of the assesses has been shifted from one market to another or one city to another.
3. Where one or the other department of the business has been closed.
4. Where the business of an industrial undertaking carried on is discounted in the previous year due to extensive damage, natural calamities, destruction of buildings, etc and revived within three years of business discontinuation.

Read More- Types of Companies & PPT is Available

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