Question

Birch Company normally produces and sells 42,000 units of RG-6 each month. The selling price is $30 per unit, variable costs are $10 per unit, fixed manufacturing overhead costs total $180,000 per month, and fixed selling costs total $30,000 per month.

Employment-contract strikes in the companies that purchase the bulk of the RG-6 units have caused Birch Company’s sales to temporarily drop to only 11,000 units per month. Birch Company estimates that the strikes will last for two months, after which time sales of RG-6 should return to normal. Due to the current low level of sales, Birch Company is thinking about closing down its own plant during the strike, which would reduce its fixed manufacturing overhead costs by $42,000 per month and its fixed selling costs by 10%. Start-up costs at the end of the shutdown period would total $14,000. Because Birch Company uses Lean Production methods, no inventories are on hand.

Required:

1. What is the financial advantage (disadvantage) if Birch closes its own plant for two months?

2. Should Birch close the plant for two months?

3. At what level of unit sales for the two-month period would Birch Company be indifferent between closing the plant or keeping it open?

Answer 1

Required 1 :
Differential Analysis
Particulars	Continue plant for 2 Months	Shut down plant for 2 Months	Increase (Decrease )In income of shutdown
	(Alternative 1 )	(Alternative 2 )	(Alternative 2 )
Sales Revenue (a)	$660,000    {11,000 units*2 Months *$ 30 }	$ 0	($660,000 )                              {$ 0 -$660,000}
Costs:
Variable cost	$220,000    {11,000 units*2 Months *$ 10 }	$ 0	($220,000 )                              {$ 0 -$220,000}
Fixed manufacturing overhead cost	$360,000             {$180,000 *2 Months }	$276,000    {($180,000-$42,000) *2 Months }	($84,000 )                       {$ 276,000 -$360,000}
Fixed selling cost	$60,000             {$30,000 *2 Months }	$54,000    {($30,000-($30,000*10%)) *2 Months }	($6,000 )                       {$ 54,000 -$60,000}
Startup cost at the end of shutdown period	$ 0	$ 14,000	$ 14,000                                  {$ 14,000 -$ 0}
Total costs (b)	$ 640,000	$ 344,000	$296,000                 {$344,000 -$ 640,000}
Income / (Loss) ( a - b )	$20,000   {$660,000 -$640,000 }	($344,000 )        {$0 -$344,000 }	($364,000)                 {($344,000) -$ 20,000}

This is Financial Disadvantage for Birch closes its own plant for Two Months = - $364,000

Required 2 :

No, Birch should not close the plants for 2 months because Net Income for Continue plant for 2 Months is $ 20,000

Required 3 :

Levels of sales to be indifferent = (Avoidable Fixed costs - Startup cost ) / Contribution margin per unit

Here, Avoidable Fixed Costs = $84,000 +$ 6,000 = $ 90,000

Here, Startup Cost = $ 14,000

Contribution margin per Unit = Selling price per unit - Variable cost per unit

Contribution margin per Unit = ($30 - $10 ) = $ 20 Per Unit

Levels of sales to be indifferent = (Avoidable Fixed costs - Startup cost ) / Contribution margin per unit

Levels of sales to be indifferent = ($90,000 - $14,000 ) / $20 per unit

Levels of sales to be indifferent = $ 76,000 / $20 per unit

Levels of sales to be indifferent = 3,800 Units