Prepared by Diane Tanner University of North Florida

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

2. Incremental Analysis Components 2 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

3. 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 3 Relevant NOT Relevant Relevant

4. Why Do We Use Relevant Costs? 4 • 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

5. Steps in Incremental Analysis 5 Step 1: Compare revenues under both alternatives • ‘Change’ in revenues = relevant revenues Step 2: Compare costs under both alternatives • ‘Change’ in costs = relevantcosts Step 3: List and clearly label each incremental item as an 1) incremental revenue, 2) incremental cost, or 3) 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

6. Qualitative Issues 6 • Should be considered regardless if the outcome says to make the decision or reject the decision • To include: • Morale • Control over design, quality, timeliness, & reliability • Environmental effects and safety • Prestige • Future price increases • Contractual issues

7. Types of Incremental Decisions • Special order • Outsourcing / Make-or-buy • Keep or Drop • A customer, product, segment, or subdivision • Capacity constraints

8. Capacity Constraints • Often called product mix decisions • Exists when demand exceeds production that is limited by a particular resource • Labor hours • Machine hours • Space • Materials • Goal is to maximize the contribution margin per unit of the constrained resource

9. The End