Chapter 10: Differential Analysis (Key to Decision Making)

Why is the Differential Approach desirable?

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.

Ways managers can increase the capacity of a bottleneck (relaxing or elevating)

1. Working overtime on the bottleneck. 2. Subcontracting some of the processing that would be done at the bottleneck. 3. Investing in additional machines at the bottleneck. 4. Focusing business process improvement efforts on the bottleneck. 5. Reducing defective units processed through the bottleneck.

Make or Buy Decision

A decision to carry out one of the activities in the value chain internally, rather than buy externally from a supplier. Basically it is a decision whether to make the product in house or outsource to an external company.

Special Order

A one-time order that is not considered part of the company's normal ongoing business. When analyzing, only the incremental costs and benefits are relevant.

Relevant Benefit

Benefit that differs between alternatives.

Avoidable Cost

Cost that can be eliminated, in whole or in part, by choosing one alternative over another. Avoidable costs are relevant costs. Unavoidable costs are irrelevant costs.

Relevant Cost

Cost that differs between alternatives.

Value of a Constrained Resource

Increasing the capacity of a constrained resource should lead to increased production and sales.

Opportunity Cost

The benefit that is forgone as a result of pursuing some course of action. Not actual cash outlays and are not recorded in the formal accounts of an organization.

Bottleneck

The machine or process that is limiting overall output. A bottleneck is one form of a constraint.

Split-off Point

The point in the manufacturing process where each joint product can be recognized as a separate product.

Joint Costs

Two or more products from a common input. Joint costs are incurred up to the split-off point. Traditionally allocated among different products at the split-off point. Irrelevant in decisions regarding what to do with a product from the split-off point forward. With respect to sell or process further decisions, it is profitable to continue processing a joint product after the split-off point so long as the incremental revenue from such processing exceeds the incremental processing costs incurred after the split-off point.

Contraint

When a limited resource of some type restricts the company's ability to satisfy demand.