Chap 20 Incremental analysis

What is incremental analysis?

The process used to identify financial fat that change under alternative courses of action. (The process of calculating results for different solutions)

List the common business decisions management may make

special orders

Make or buy? (Outsourcing)

Opportunity

Sell or process further?

Repair, retain, or replace equipment?

Eliminate unprofitable product

Why is it important to analyze more than one alternative?

Different alternatives may have misleading results, so it’s important to analyze all options to compare.

Special orders

Sometimes, to obtain additional business, companies may make a major price cut to specific customers. Assuming sales of other products aren’t affected and that they are not running at full capacity.

When should special orders be accepted?

Should be accepted when incremental revenue exceeds incremental costs. Duh

Opportunity costs

Is the lost potential benefit that could have been obtained from following an alternative course of action.

Sell or process further?

You might have the option to sell products at a given point in production or process further at a higher price.

When should you decide to process further?

Should process further when incremental revenue exceeds incremental costs. Duh

Repair retain or replace equipment

When deciding whether to repair retain replace equipment, you may want to consider the manufacturer in costs, new machine costs, the sale of the old machine and any trade in value.

What are sunk costs?

Are future costs that can’t be avoided and thus are NOT relevant. Ex: joint product costs, book value of old machine.

Eliminate unprofitable products

When deciding whether to eliminate an unprofitable product, consider the relevant costs, the effect on related product lines and all FIXED COSTS MUST BE ABSORBED by other products. Net income may decrease when you eliminate an unprofitable product.

When should you retain a product?

Retain the segment unless the fixed costs exceed the contribution margin

Qualitative factors

Factors affecting decisions that are not easily expressed in terms of numbers or dollars. Ex ,employee morale, company image, and corporate social responsibility.

What are the steps that incremental analysis usually follow ?

Identify the proble

Determine and evaluate possible courses of action

Make a decision

Review results