Sometimes it becomes necessary for a firm to temporarily close down its factory or a segment due to trade recession. The decision regarding the closure will depend on whether products are making a contribution towards fixed costs or not. If the products are making a contribution towards fixed cost, it is not advisable to close the factory or segment to minimize the losses. Even though the factory is closed down, some fixed costs could not be avoided; for instance, maintenance of plant or overhauling etc.  So these must be taken into account while making decision.

In addition to the cost consideration, some non-cost considerations should be taken into account before deciding to close down a factory or segment. The following are relevant in this respect:

1. Once the business is closed down, its competitors may take the advantage to establish their products and capture the business of the company. It is difficult to recapture the market. Heavy advertisement costs have to be incurred to recapture the market.

2. Once the workers are discharged it may be difficult to get experienced and skilled laborers again to restart the business.

3. If some segment or activities are closed down, it may effect the reputation of the firm.

4. Temporary close down may not be advisable if it adversely effects its relationship with the suppliers.

5. Fear of non-collection of dues from debtors in case of closure of business may not go in its favor.

Illustration 

Moon Ltd., manufactures 60,000 units of 'A' in a year at its normal production capacity. The unit cost as to variable costs and fixed costs at this level are Rs.13 and Rs.4 respectively. The selling price of the A is Rs.20. Due to trade depression, it is expected that only 6,000 units of 'A' can be sold during the next year. The management plans to shut down the plant. The fixed cost for the next year then is expected to be reduced to Rs.99,000. Additional costs of plant shut-down are expected at Rs.36,000. Should the plant be shut down? What is shut down point?

Solution

Comparative Statement

Recommendation: A comparison of figures relating to two alternatives points out that loss is reduced by Rs.46,000 if the plant is shutdown.

Calculation of shut down point:

Shutdown point               = Total fixed cost - Shutdown cost/Contribution per unit

                                    = Rs.2,40,000 - Rs.1,26,000/Rs.20 - Rs.13

                                    =  16,285 units.

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