Professional Documents
Culture Documents
Incremental Analysis
ASSIGNMENT CLASSIFICATION TABLE
Study Objectives
Questions
Brief
Exercises
Exercises
A
Problems
B
Problems
1.
1, 2
2.
3, 4
3.
2, 3, 4, 14
1A
1B
4.
6, 7
5, 6, 14
2A
2B
5.
8, 9, 10
5, 6
7, 8, 9, 14
3A
3B
6.
11
10, 11, 14
4A
4B
7.
12
12, 13, 14
5A
5B
7-1
Description
Difficulty
Level
Time
Allotted (min.)
Simple
2030
1A
2A
Moderate
3040
3A
Moderate
3040
4A
Moderate
3040
5A
Moderate
3040
1B
Simple
2030
2B
Moderate
3040
3B
Moderate
3040
4B
Moderate
3040
5B
Moderate
2030
7-2
7-3
*3.
*4.
*5.
*6.
*7.
*2.
Q7-8
Q7-9
Q7-10
BE7-8
Q7-12
E7-7
E7-8
E7-9
BE7-5
BE7-6
P7-5A
P7-5B
P7-4A
P7-4B
E7-14
P7-3A
P7-3B
P7-2A
P7-2B
Managerial Analysis
Decision Making
Across the
Organization
Ethics Case
Communication
E7-12
E7-13
E7-14
E7-10
E7-11
E7-14
E7-5
E7-6
E7-14
BE7-4
E7-14
P7-1A
P7-1B
Evaluation
E7-2
E7-3
E7-4
Synthesis
BE7-3
BE7-2
Analysis
BE7-7
E7-1
E7-1
Application
Q7-11
Q7-6
Q7-7
Q7-5
Q7-3
Q7-4
Q7-1
Q7-2
Knowledge Comprehension
*1.
Study Objective
Correlation Chart between Blooms Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems
STUDY OBJECTIVES
1. IDENTIFY THE STEPS IN MANAGEMENTS DECISIONMAKING PROCESS.
2. DESCRIBE THE CONCEPT OF INCREMENTAL ANALYSIS.
3. IDENTIFY THE RELEVANT COSTS IN ACCEPTING AN
ORDER AT A SPECIAL PRICE.
4. IDENTIFY THE RELEVANT COSTS IN A MAKE OR BUY
DECISION.
5. IDENTIFY THE RELEVANT COSTS IN DETERMINING
WHETHER TO SELL OR PROCESS MATERIALS
FURTHER.
6. IDENTIFY THE RELEVANT COSTS TO BE CONSIDERED IN RETAINING OR REPLACING EQUIPMENT.
7. IDENTIFY THE RELEVANT COSTS IN DECIDING
WHETHER TO ELIMINATE AN UNPROFITABLE
SEGMENT.
7-4
CHAPTER REVIEW
Incremental Analysis
1.
2.
(S.O. 2) Business decisions involve a choice among alternative courses of action. In making such
decisions, management ordinarily considers both financial and nonfinancial information. The
process used to identify the financial data that change under alternative courses of action is called
incremental analysis.
a. Incremental analysis involves not only identifying relevant revenues and costs, but also
determining the probable effects of the decision on future earnings.
b. Data for incremental analysis involves estimates and uncertainty.
c. Gathering data may involve market analysts, engineers, and accountants.
3.
In incremental analysis, both costs and revenues may change. However, in some cases
(1) variable costs may not change under the alternative courses of action, and (2) fixed costs may
change.
(S.O. 3) An order at a special price should be accepted when the incremental revenue from the
order exceeds the incremental costs.
a. It is assumed that sales in other markets will not be affected by the special order.
b. If the units can be produced within existing plant capacity, generally only variable costs will
be affected.
Make or Buy
5.
(S.O. 4) In a make or buy decision, management must determine the costs which are different
under the two alternatives. If there is an opportunity to use the productive capacity for another
purpose, opportunity cost should be considered. Opportunity cost is the potential benefit that
may be obtained by following an alternative course of action. This cost is an additional cost of
making the component.
(S.O. 5) The basic decision rule in a sell or process further decision is: Process further as long
as the incremental revenue from such processing exceeds the incremental processing costs.
Incremental revenue is the increase in sales which results from processing the product further.
7-5
(S.O. 6) In a decision to retain or replace equipment, management compares the costs which
are affected by the two alternatives. Generally, these are variable manufacturing costs and the
cost of the new equipment.
a. The book value of the old machine is a sunk cost which does not affect the decision. A sunk
cost is a cost that cannot be changed by any present or future decision.
b. However, any trade-in allowance or cash disposal value of the existing asset must be
considered.
9.
Many of the decisions involving incremental analysis also have important qualitative features.
7-6
LECTURE OUTLINE
A.
TEACHING TIP
b.
c.
Make a decision.
d.
B.
Incremental Analysis.
1. The process used to identify the financial data that change under
alternative courses of action is called incremental analysis.
TEACHING TIP
7-7
2. These data are relevant to the decision because they will vary in the
future among the possible alternatives.
3. Incremental analysis sometimes involves changes that might seem
contrary to your intuition. For example, sometimes:
a.
b.
TEACHING TIP
b.
If other sales are affected, then the company would have to consider
the lost sales in making the decision.
c.
7-8
5. Make or buy.
TEACHING TIP
b.
The basic decision rule is: Process further as long as the incremental revenue from such processing exceeds the incremental
processing costs.
c.
d.
All costs incurred prior to the point at which the two products are
separately identifiable (the split-off point) are called joint costs.
7-9
e.
f.
b.
c.
d.
The book value of the old asset does not affect the decision. Book
value is a sunk cost, which is a cost that cannot be changed by any
present or future decision.
b.
In deciding on the future status of an unprofitable segment, management should consider the effect of elimination on related segments.
c.
Management should also consider the effect of eliminating the segment on employees who may have to be discharged or retrained.
7-10
20 MINUTE QUIZ
Circle the correct answer.
True/False
1.
2.
In incremental analysis fixed costs may not change under alternative courses of action,
while variable costs may change.
True
3.
False
Joint product costs are relevant for any sell-or-process further decisions.
True
10.
False
9.
False
Opportunity costs are costs that have already been incurred and will not be avoided by
any future decision.
True
8.
False
7.
False
Book value is a sunk cost and is therefore relevant in incremental analysis of retain or
replace equipment.
True
6.
False
The basic decision rule to sell or process further is: process further as long as the
incremental revenue from such processing exceeds the incremental processing costs.
True
5.
False
The relevant information to consider in accepting an order at a special price are the
additional manufacturing costs incurred and expected revenues.
True
4.
False
False
Any trade-in allowance or cash disposal value of the old asset is relevant in a retain or
replace equipment decision.
True
False
7-11
Multiple Choice
1.
2.
If revenues are $315,000 under alternative A and $324,000 under alternative B, and
costs are $285,000 for A and $306,000 for B, then using the basic approach in
incremental analysis, incremental revenues, costs, and net income, in comparing B to A
are respectively
a. $9,000, $(21,000), $(12,000).
b. $(9,000), $21,000, $12,000.
c. $9,000, $21,000, $12,000.
d. $(9,000), $(21,000), $(12,000).
3.
The cost to manufacture an unfinished unit is $120 ($90 variable, $30 fixed). The selling
price per unit is $150. The company has unused productive capacity and has determined
that units could be finished and sold for $195 with an increase in variable costs of 40%.
What is the additional net income per unit to be gained by finishing the unit?
a. $9.
b. $30.
c. $45.
d. $36.
4.
The potential benefit that may be obtained from following an alternative course of action
is called
a. opportunity benefit.
b. opportunity cost.
c. relevant cost.
d. sunk cost.
5.
In a make or buy decision, the relevant costs include each of the following except the
a. variable manufacturing costs that will be saved.
b. fixed manufacturing costs that can be eliminated.
c. opportunity costs.
d. each of the above is a relevant cost.
7-12
ANSWERS TO QUIZ
True/False
1.
2.
3.
4.
5.
True
True
True
True
False
6.
7.
8.
9.
10.
False
False
True
False
True
Multiple Choice
1.
2.
3.
4.
5.
d.
a.
a.
b.
d.
7-13
ILLUSTRATION 7-1
MANAGEMENTS DECISION-MAKING PROCESS
7-14
ILLUSTRATION 7-2
TYPES OF INCREMENTAL ANALYSIS
1.
2.
3.
4.
5.
7-15
ILLUSTRATION 7-3
INCREMENTAL ANALYSISSPECIAL ORDER PROPOSAL
Your company produces 10,000 units which is 80% of capacity and its normal
selling price is $25/unit.
The following cost data are provided at 10,000 units:
Variable cost per unit
$16
Fixed cost per unit
4
Will you accept a special order from a foreign company for an additional
Yes
2,000 units at a price of $22/unit?
No
Those of you who said "yes," would you
Yes
accept the order at $19/unit?
No
Those of you who said "yes," would you
Yes
accept the order at $15/unit?
No
$22
$294,000
(192,000 )
(40,000 )
$ 62,000
$19
$15
$288,000
(192,000 )
(40,000 )
$ 56,000
$280,000
(192,000 )
(40,000 )
$ 48,000
Change in revenue
Change in costs
$44,000
32,000
$38,000
32,000
$30,000
32,000
$12,000
$ 6,000
$ (2,000 )
Sales
Variable costs
Fixed costs
Net income
$250,000
(160,000 )
(40,000 )
$ 50,000
7-16
ILLUSTRATION 7-4
INCREMENTAL ANALYSISMAKE OR BUY
Unit Cost
$ 60,000
85,000
$12
17
40,000
90,000
$275,000
8
18
$55
7-17
Make
Direct materials
Buy
Net Income
Increase
(Decrease)
$ 60,000
$ 0
$ 60,000
Direct labor
85,000
85,000
40,000
40,000
90,000
55,000
35,000
250,000
(250,000 )
$275,000
$305,000
$ (30,000 )
Make
Buy
Increase
(Decrease)
$275,000
$305,000
$ (30,000 )
Opportunity cost
36,000
36,000
$311,000
$305,000
$ 6,000
7-18