ACCT222: CH. 12 Differential Analysis

adding/dropping segments

-decision to add/drop segment hinges primarily on the impact on the net operating income -to assess impact it is necessary to analyze costs -we can use relevant costs in this decision

types of approaches

total and differential cost approach contribution margin approach

make or buy decision

When a company is involved in more than one activity in the entire value chain, it is vertically integrated. A decision to carry out one of the activities in the value chain internally, rather than to buy externally from a supplier, is called a make or buy decision.

constraint decisions

When a limited resource of some type restricts the company's ability to satisfy demand, the company is said to have a constraint. The machine or process that is limiting overall output is called the bottleneck - it is the constraint.

identifying relevant costs

an avoidable cost can be eliminated, in whole or in part, by choosing one alternative over another -avoidable costs are relevant costs -unavoidable costs are irrelevant costs

sell or process further

Joint costs are irrelevant in decisions regarding what to do with a product from the split-off point forward. It will always be profitable to continue processing a joint product after the split-off point so long as the incremental revenue exceeds the incremental processing costs incurred after the split-off point.

relevant cost

cost that differs between alternatives

sell or process further- joint costs

-In some industries, a number of end products are produced from a single raw material input. -Two or more products produced from a common input are called joint products. -The point in the manufacturing process where each joint product can be recognized as a separate product is called the split-off point.

total and differential cost approaches

-requires constructing two contribution format statements, one for each alternative

relevant cost analysis: two step process

1. eliminate costs and benefits that do not differ between alternatives -a.k.a. irrelevant costs 2. use the remaining costs and benefits that differ between alternatives in making the decision. The costs that remain are the differential, or avoidable, costs - Costs that are relevant in one decision situation may not be relevant in another context. Thus, in each decision situation, the manager must examine the data at hand and isolate the relevant costs.

using the differential approach is desirable for two reasons

1. only rarely will enough information be available to prepare detailed income statements for both alternatives 2. mingling irrelevant costs with relevant costs may cause confusion and distract attention away from the information that is really critical

two broad categories of costs are never relevant in any decision

1. sunk costs 2. future costs that [do not differ] between the alternatives

special order decisions

A special order is a one-time order that is not considered part of the company's normal ongoing business. When analyzing a special order, only the incremental costs and benefits are relevant. Since the existing fixed manufacturing overhead costs would not be affected by the order, they are not relevant.

opportunity cost

An opportunity cost is the benefit that is foregone as a result of pursuing some course of action. Opportunity costs are not actual dollar outlays and are not recorded in the formal accounts of an organization.

utilization of a constrained resource

Fixed costs are usually unaffected in these situations, so the product mix that maximizes the company's total contribution margin should ordinarily be selected. A company should not necessarily promote those products that have the highest unit contribution margin. Rather, total contribution margin will be maximized by promoting those products or accepting those orders that provide the highest contribution margin in relation to the constraining resource.