Chapter 25: Differential Analysis and Product Pricing

Learning Objectives

  • Prepare differential analysis reports for managerial decisions.

  • Determine selling prices using the product cost method.

  • Manage manufacturing bottlenecks effectively.

  • Apply yield pricing in service businesses.

Differential Analysis

  • Focuses on evaluating differential revenues and costs to assess profit impacts.
      - Differential Revenue: The expected revenue increase or decrease from a decision.
      - Differential Cost: The expected cost increase or decrease from a decision.
      - Differential Profit/Loss: Difference between differential revenue and cost, indicating income impact.

Application Examples

Bryant Restaurants Case

  • Analysis between keeping tables vs. installing a salad bar.
      - Differential Revenue: $20,000 from salad bar.
      - Differential Cost: -$5,000 for increased costs.
      - Differential Profit: $15,000 increase from the salad bar decision.

Lease or Sell Equipment

  • Management decision based on the differential revenues and costs related to the lease or sale.
      - Book value is a sunk cost and irrelevant to analysis.

Discontinuing a Segment

  • Variable costs eliminated if a product segment is discontinued, but some fixed costs remain.

  • Potential for company income to decrease.

Make or Buy Decision

  • Comparison of costs between manufacturing in-house vs. purchasing externally, utilizing differential analysis.
      - E.g., Cost per unit for manufacturing vs. purchase price analysis.

Replace Equipment

  • Consider usefulness over time to inform decisions about existing assets, analyzing costs of old vs. new assets.

Process or Sell Decision

  • Analyze profitability of selling an intermediate product vs. further processing it.

Accepting Special Price Offers

  • Evaluate special pricing scenarios compared to normal price, especially under capacity.

Setting Product Selling Prices

Pricing Methods

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  • Demand-based: Price determined by market demand.

  • Competition-based: Price adjusts to competitors’ pricing.

  • Cost-plus: Price set by adding a markup to cost to ensure profit.

Target Costing

  • Combination of market-based pricing with cost reductions to maintain profits.

  • Target cost = Selling price - Desired profit.

Production Bottlenecks

  • Identifying bottlenecks to maximize profit is crucial.

  • Use unit contribution margin per capacity constraint to determine profitability.