Prepared by Diane Tanner University of North Florida

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

2. Incremental Analysis 2 • 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

3. Incremental Analysis Components 3 Incremental Revenue The additional revenue as a result of selecting one decision over another Incremental Cost The additional cost as a result of selecting one alternative over another Incremental Savings The reduction of cost as a result of selecting one alternative over another Usually combined/netted with incremental costs

4. Avoidable Cost: can be avoided if a certain decision is made Sunk Cost: a cost that has already been incurred and irreversible Opportunity Cost: Represents the benefit forgone by selecting one alternative over another Terminology 4 Relevant NOT Relevant Relevant

5. Why Do We Use Relevant Costs? 5 • 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 Not Relevant Relevant

6. Steps in Incremental Analysis 6 Step 1: Compare revenues under both alternatives • The difference in revenues that change is the amount of relevant revenues • If revenues change, the difference is the incremental amount. Ignore all irrelevant revenues. Step 2: Compare costs under both alternatives • Costs that do not change are not relevant, so omit all irrelevant costs, including sunk costs. • List the amount of the change in costs because this is the only amount that is relevant.

7. Steps in Incremental Analysis cont 7 Step 3: Separate relevant costs into variable and fixed categories. Step 4: List and clearly label each incremental revenue, incremental cost, and incremental cost savings. • Include a + sign if the incremental amount increases profit (i.e., a benefit). • Show the amount in ( ) parentheses if the amount causes profit to decline.

8. Qualitative Issues 8 • Should be considered regardless if the outcome says to make the decision or reject the decision

9. The End