Differential analysis focusing on the costs and benefits that differ between alternatives when making
decisions.
- Differential cost (relevant costs) difference in cost between any two alternatives
- Differential revenue (relevant benefits) difference in revenue between any two alternatives
*Costs and Revenues that do not differ between alternative options are irrelevant to decision making.
Irrelevant data can be ignored, so we must be able to tell the difference.
Avoidable cost a cost that can be eliminated by choosing one alternative over another.
- For example decision of going to movies or stay home and rent DVD
o If we choose going out to movies, the cost of renting a DVD is avoidable
o If we choose staying home and renting DVD, the cost of going out to movies is avoidable
o Rent on your apartment is unavoidable, not matter what option is chosen
Avoidable costs are relevant costs (cost of going out to movie or staying in and renting DVD).
Unavoidable costs are irrelevant costs (cost of apartment rent).
Sunk Cost cost that has already been incurred and cannot be avoided, no matter what a manager
decides to do
- Sunk costs are irrelevant costs
Opportunity Cost potential benefit that is given up when one alternative is selected over another
The decision to add or drop a product line/segment, usually all depends on the impact to net operating
income. However, this decision must be carefully analyzed by costs to get an accurate decision.
Comparative Format:
Decision to Make or Buy
Vertically integrated when a company is involved in more than one activity in the whole value chain.
- Value chain are all the steps necessary to develop and sell a product
Make or Buy decision the decision to carry out one of the activities in the value chain internally, rather
than to buy externally from a supplier
Mountain Goat Cycles is currently making heavy-duty gear shifters, a material that is used in its line of
mountain bikes. Accounting department reports the below costs to produce the 8,000 units that are
needed each year.
Outside supplier has offered to sell 8,000 gear shifters to Mountain Goat Cycles at a price of $19 each, or
total of $152,000 (8,000 X $19).
However, what if the space now being used to produce the gear shifters could be used for another
purpose? If so, then the space would have an opportunity cost equal to the segment margin that would
come from the best alternative space.
If the space now being used for shifters, could be used to produce a new cross-country bike that would
generate a segment margin of $60,000, the cost analysis now looks like the following:
This opportunity cost now changes our decision to purchase from outside supplier.
Special order one-time order that is not considered part of the companys normal ongoing business.
Police department wants Mountain Goat Cycles to produce a special order of 100 bikes at $558 each.
Mountain Goat could modify a current model, the City Cruiser bike which sells for $698 and product cost
is $564, broken out on next page.
Variable portion of Manufacturing Overhead is $12 per unit. The special order has no effect on the
companys total fixed OH costs. Modifications to police order would cost $34 per bike and a fixed cost
to produce a stencil would be $2,400.
Since incremental revenue exceeds the incremental costs, Mountain Goat should accept the special
order.
Constraint anything that prevents you from getting more of what you want.
- Airline has limited # of gates available at airports they land at
o Constraint is loading gates
- Constraint, or bottleneck, is determined by the step that limits total output due to smallest capacity
Sell or process further decisions is it profitable to continue processing a joint product after the split-off
point?
- As long as the incremental revenue from such processing exceeds the incremental processing cost
incurred after the split-off point.
o Joint costs that have already been incurred up to the split-off point are always irrelevant in
decisions concerning what to do from the split-off point forward
**Company should sell the un-dyed Coarse Wool and not process further, but should process the Fine
and Superfine Wool further.