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INCREMENTAL
ANALYSIS
Chapter
7-1
Preview of Chapter
Chapter
7-2
Incremental Analysis
Management’s Types of
Other
Decision-Making Incremental
Considerations
Process Analysis
Chapter
7-4
Management’s Decision-making Process
Chapter
7-5
Incremental Analysis Approach
Chapter
7-6
Incremental Analysis
Chapter
7-7
How Incremental Analysis Works
Uses Three Important Cost Concepts
Chapter
7-8
Let’s Review
Chapter
7-9
Types of Incremental Analysis
Chapter
7-10
Accept or reject an Order at a Special Price
Chapter
7-11
Accept or reject an Order at a Special Price
Example
Mexico Co. offers to buy a special order of 2,000
blenders at $11 per unit from Sunbelt.
No effect on normal sales; sufficient plant capacity
Operating at 80 percent capacity = 100,000 units
Current fixed manufacturing costs = $400,000 or $4 per unit
Variable manufacturing cost = $8 per unit
Normal selling price = $20 per unit
Chapter
7-13
Let’s Review
It costs a company $14 of variable costs and $6 of
fixed costs to produce product Z200 that sells for
$30. A foreign buyer offers to purchase 3,000 units
at $18 each. If the special offer is accepted and
produced with unused capacity, net income will:
a. Decrease $6,000.
b. Increase $6,000.
c. Increase $12,000.
d. Increase $9,000.
Chapter
7-14
Let’s Review (Computations)
Since there is sufficient capacity there is no additional fixed cost
required.
Chapter
7-15
Make or Buy
Chapter
7-16
Make or Buy – Example Continued
Chapter
7-17
Make or Buy – Example Continued
Opportunity Costs
Definition: The potential benefits that may be
obtained from following an alternative course of
action.
Chapter
7-19
Make or Buy – Opportunity Cost Example
• This opportunity cost, the lost income, is
added to the “Make” column as an additional
“cost” for comparative purposes
Chapter
7-21
Sell or Process Further
Decision Rule:
Process further as long as
the incremental revenue from
such processing exceeds the
incremental processing costs
Chapter
7-22
Sell or Process Further - Example
Single-Product Case
Cost to manufacture one unfinished table:
Chapter
7-23
Sell or Process Further
Chapter
7-24
Sell or Process Further
Multiple-Product Case
Chapter
7-25
Sell or Process Further
Multiple-Product Case
All costs incurred prior to the point at which the products are
separately identifiable (the split-off point) are called joint costs
Chapter
7-26
Sell or Process Further - Example
Multiple-Product Case
Chapter
7-27
Sell or Process Further – Example Continued
The daily cost and revenue data for Marais Creamery are:
Chapter
7-28
Sell or Process Further – Example Continued
Chapter
7-29
Sell or Process Further
Chapter
7-30
Let’s Review
The decision rule in a sell-or-process-further decision
is:
process further as long as the incremental
revenue from processing exceeds:
Chapter
7-31
Retain or Replace Equipment
Management must decide whether a company should
continue to use an asset or replace it
Example: Assessment of replacement of a factory
machine:
Old Machine New Machine
Book value $40,000
Cost $120,000
Remaining useful life four years four years
Scrap value -0- -0-
Variable costs:
Decrease from $160,000
to $125,000 annually
Chapter
7-32
Retain or Replace Equipment - Example
a. Opportunity cost.
b. Sunk cost.
c. Incremental cost.
d. Marginal cost.
Chapter
7-34
Eliminate an Unprofitable Segment
Chapter
7-35
Eliminate an Unprofitable Segment - Example
Chapter
7-37
Eliminate an Unprofitable Segment - Example
Incremental analysis of Champ provides the same
results:
Chapter
7-38
Let’s Review
Chapter
7-39 LO 7: Identify the relevant costs in deciding whether
to eliminate an unprofitable segment .
Other Considerations in Decision Making
Chapter
7-40
Q&A
Chapter
7-41
Chapter Review - Exercise 7-1
Identify each of the following statements as true or false.
1. The first step in management’s decision-making process is False
“Determine and evaluate possible courses of action.”
Chapter
7-42
Chapter Review - Exercise 7-1 Continued
Identify each of the following statements as true or false.
5. Decisions involve a choice among alternative courses of True
action.
Chapter
7-43