One of the more difficult decisions any management must make is when it is confronted with the situation of abandoning a business unit which is performing poorly. Such decisions are expected to have far reaching effect on the various internal and external stakeholders of the company. The fixed cost is unavoidable, and in any business decision making on closing a business unit the focus should be on such unavoidable costs. These costs are those future costs which are expected to differ for the alternative decisions under consideration. The objective of any business decision is to identify the scenario which yields the best incremental outcome as it relates to the unavoidable costs. The management shouldn’t conclude that any business segment which results in a net loss is to be eliminated. This would be an error committed by those who do not have sufficient accounting knowledge to look beyond the bottom level of the organization (Principles of Accounting). In some case eliminating a unit will result in the reduction of the overall performance of the company. Such a decision will result in the absorption of the fixed costs by the remaining units and this is likely to create a dominos effect where the unit shut down will affect the profitability of the surviving units. The appropriate analysis will be to compare net income of the company as a total with or without the unit proposed to be closed down.
The decision whether to continue running location C or to shut down can be decided based on the contribution margin from the location. Contribution margin is the difference between the selling price and variable costs. Contribution margin plays an important role in taking various managerial decisions concerning the continuance or change in the product lines or even discontinuance of a store location (Horngren, Foster and Datar). Even though many of the retail store operations do not use the concept of store contribution margin, for taking decisions concerning specific stores, contribution margin still can be used to evaluate the decision of shutting down a store location (Microsoft).
In the case of location C the decision of shutting down is to be viewed taking into account the impact of contribution margin on the operating income and net income and the long-term commitment of lease rentals representing the fixed costs associated with the location.
Even though the operations from location C results a net loss, the contribution margin adds to the operating income and covers a part of the fixed expenses. In case the decision is taken to shut down location C the fixed expenses of $ 380,000 is to be absorbed by the other locations A and B and this would affect the profitability of these locations to the extent they have to bear the fixed expenses each. The contribution margin of $ 67,300 from location C goes to reduce the fixed expense cost of $ 380,000 and when the location is shut down the company will lose this contribution and this action will reduce the operating income by the amount of contribution from location C.
Shutting down location C will not help the overall situation of the company. The reallocation of fixed costs to other locations and the loss of contribution margin from location C in the contingency of shutting down the location strongly suggest the continuance of location C.
Work Cited
Horngren, Charles T, Georege Foster and Srikant M Datar. Cost Accounting: A Managerial Emphasis. New Delhi: Prentice Hall of India Private Limited, 2002.
Microsoft. Winning Strategies for the Retail Industry. 2009. Web.
PrinciplesofAccounting. Chaper 24 Analytics for Managerial Decision Making. 2009. Web.