ACCA PM · Guided practice (Show me how)
Chapter 9: Short-term decision making
Shutdown decisions: lost contribution against avoidable costs
(a) A company manufactures three products, Pawns, Rooks and Bishops. The present net annual income from these is as follows:
| Pawns $ | Rooks $ | Bishops $ | Total $ | |
|---|---|---|---|---|
| Sales | 50,000 | 40,000 | 60,000 | 150,000 |
| Less variable costs | 30,000 | 25,000 | 35,000 | 90,000 |
| Contribution | 20,000 | 15,000 | 25,000 | 60,000 |
| Less fixed costs | 17,000 | 18,000 | 20,000 | 55,000 |
| Profit / (loss) | 3,000 | (3,000) | 5,000 | 5,000 |
The company is considering whether or not to cease selling Rooks. It is felt that selling prices cannot be raised or lowered without adversely affecting net income. $5,000 of the fixed costs of Rooks are direct fixed costs which would be saved if production ceased. All other fixed costs would remain the same.
(b) Suppose, however, that it were possible to use the resources released by stopping production of Rooks to produce a new item, Crowners, which would sell for $50,000 and incur variable costs of $30,000 and extra direct fixed costs of $6,000.
Consider whether the company should cease production and sale of Rooks under each of the scenarios in (a) and (b).
(a) Should Rooks be dropped?
Calculate the company's annual contribution lost, fixed costs saved and change in profit if Rooks is discontinued.
(b) Rooks replaced by Crowners
Calculate the company's annual contribution from Crowners and change in profit if Crowners replaces Rooks.
Opening this exercise…