1. Incremental Analysis Managerial Accounting Prepared by Diane Tanner University of North Florida Chapter 11

2. Incremental Analysis  What is it?  Analysis of relevant revenues and expenses  Incremental = Relevant = Differential  General Rule  Only amounts which differ between alternatives will impact the decision, so ignore all other amounts 2

3. Incremental Analysis Components Incremental Revenue The additional revenue as a result of selecting one decision over another Incremental Revenue The additional revenue as a result of selecting one decision over another Incremental Costs The additional costs as a result of selecting one alternative over another Incremental Costs The additional costs as a result of selecting one alternative over another Incremental Savings The reduction of costs as a result of selecting one alternative over another Incremental Savings The reduction of costs as a result of selecting one alternative over another Often combined/netted together 3 Opportunity Costs The amount given up as a result of selecting one alternative over another Opportunity Costs The amount given up as a result of selecting one alternative over another

4. Terminology Avoidable Cost: Amounts that can be avoided if a certain decision is made Sunk Cost: A cost that has already been incurred and is irreversible Opportunity Cost: Represents the benefit forgone by selecting one alternative over another 4

5. Why Do We Use Relevant Costs?  Allows us to focus on only the few things that matter  Much quicker decision making  Mingling irrelevant costs with relevant costs may cause confusion and distract attention from critical matters 5

6. Steps in Incremental Analysis Step 1: Compare revenues under both alternatives Step 2: Compare costs under both alternatives  Additional costs decrease profit.  Cost savings increase profit. Step 3: List and clearly label each incremental revenue, incremental cost, incremental cost savings, and opportunity cost.  Include a + sign if the incremental amount increases profit  Show the amount in ( ) parentheses if the amount causes profit to decline Step 4: Total the incremental amounts and label the effect on profit. 6 Costs that do not differ between the two decisions are not relevant, so omit all irrelevant costs, including sunk costs.

7. 7 Qualitative Issues  Considerations that cannot be quantified  Should be considered regardless if the outcome says to make the decision or reject the decision  Some examples:  Quality of the product or component if outsourced  Employee morale  Ambience  Perception of the community  Service to customers  Contribution to the 'green' environment  Goodwill as a corporate citizen  Safety

8. 8 The End