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Incremental Analysis
Making decisions is an important management function.
Does not always follow a set pattern.
Decisions vary in scope, urgency, and importance.
In making business decisions,
Considers both nancial and non-nancial information:
Financial information
Revenues and costs, and
Eect on overall protability.
Incremental Analysis Approach
Decisions involve a choice among alternative actions.
!rocess used to identify the nancial data that change under
alternative courses of action.
"oth costs and revenues may vary or
#nly revenues may vary or
#nly costs may vary
How Incremental Analysis Works
Non!nancial information
Eect on employee
turnover$he nvironment
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%ncremental revenue is &'(,))) lessunder *lternative ".
%ncremental cost sa"ingsof &+),))) is realied.
*lternative " produces #$,%%% more net income.
Important concepts used in incremental analysis&
'- Relevant cost. +- #pportunity cost. - un/ cost.
How Incremental Analysis Works
ometimes involves changes that seem contrary to
intuition.
0ariable costs sometimes do not change under alternatives.
1i2ed costs sometimes change between alternatives.
%ncremental analysis not the same as C0! analysis.
'ypes of Incremental Analysis &
'. *ccept an order at a special price.
+. 3a/e or buy component parts or nished products.
. ell or process further them further
4. Repair, retain, or replace e5uipment.
(. Eliminate an unprotable business segment or product.
Accept an (rder at a )pecial *rice- #btain additional business by ma/ing a ma6or price concession to a
specic customer.- *ssumes that sales of products in other mar/ets are not aected by
special order.- *ssumes that company is not operating at full capacity
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+Accept an (rder at a )pecial *rice
'- unbelt Company produces ')),))) moothie blenders per month,
which is 7)8 of plant capacity. 0ariable manufacturing costs are &7 per unit.
1i2ed manufacturing costs are &4)),))), or &4 per unit. $he blenders are
normally sold directly to retailers at &+) each. unbelt has an oer from
9ensington Co. a foreign wholesaler; to purchase an additional +,)))
blenders at &'' per unit. *cceptance of the oer would not aect normal
sales of the product, and the additional units can be manufactured without
increasing plant capacity. What should management do
Fi-ed costsdo not change since within e2isting capacity < thus 2ed
costs are not rele"ant.
ariable manufacturing costsand e2pected revenues change < thus
both are rele"antto the decision.
+- Cobb Company incurs costs of &+7 per unit &'7 variable and &')
2ed; to ma/e a product that normally sells for &4+. * foreign
wholesaler oers to buy (,))) units at &+( each. Cobb will incur
additional shipping costs of &' per unit. Compute the increase or
decrease in net income Cobb will realie by accepting the special
order, assuming Cobb has e2cess operating capacity. hould Cobb
Company accept the special order=
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/Make or buy component parts or !nished products.
'- "aron Company incurs the following annual costs in producing +(,)))
ignition switches for motor scooters.
%nstead of ma/ing its own switches, "aron Company might purchase theignition switches at a price of &7 per unit. 1i2ed costs will reduced by &
'),))). 0What should management do1
$otal manufacturing cost is &' higher per unit than purchase price.
3ust absorb at least &(),))) of 2ed costs under either option
(pportunity 2ost$he potential bene!tthat may be obtained from following an
alternative course of action.
+- *ssume that through buying the switches, "aron Company can use the
released productive capacity to generate additional income of &7,)))
from producing a dierent product. $his lost income is an additional
cost of continuing to ma/e the switches in the ma/e-or-buy decision.
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- >uanita Company must decide whether to ma/e or buy some of its
components for the appliances it produces. $he costs of producing
'??,))) electrical cords for its appliances are as follows:
Direct materials &@),))) 0ariable overhead &+,)))
Direct labor +),))) 1i2ed overhead +4,)))
%nstead of ma/ing the electrical cords at an average cost per unit of &'.))
&'??,))) A '??,)));, the company has an opportunity to buy the cords at
&).@) per unit. %f the company purchases the cords, all variable costs and
one-fourth of the 2ed costs will be eliminated.
a; !repare an incremental analysis showing whether the company
should ma/e or buy the electrical cords.b; Bill your answer be dierent if the released productive capacity
will generate additional income of &(,)))=
3a4 *repare an incremental analysis showing whether the company
should make or buy the electrical cords.
>uanita Company will incur &',4)) of additional costs if it buys the electrical
cords rather than ma/ing them.
3b4 Will your answer be di5erent if the released producti"e capacity
will generate additional income of #$,%%%
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es, net income will be increased by &,?)) if >uanita Company purchasesthe electrical cords rather than ma/ing them.
6)ell or process them further
3ay have option to sell product at a given point in production or to
process further and sell at a higher price.
7ecision 8ule:
!rocess further as long as the incremental revenue from suchprocessing e2ceeds the incremental processing costs.
+ ell or !rocess 1urther - ingle-!roduct Case
Boodmasters %nc. ma/es tables. $he cost to manufacture an unnished
table is &(. $he selling price per unnished unit is &(). Boodmasters has
unused capacity that can be used to nish the tables and sell them at &?)
per unit. 1or a nished table, direct materials will increase &+ and direct
labor costs will increase &4. 0ariable manufacturing overhead costs willincrease by &+.4) ?)8 of direct labor;. o increase is anticipated in 2ed
manufacturing overhead.
'he incremental analysis on a per unit basis is as follows.
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hould Boodmasters sell or process further=
+-ell or !rocess 1urther - 3ultiple-!roduct Case>oint product situation for 3arais Creamery. Cream and s/im mil/ are
products that result from the processing of raw mil/.
>oint product costs are sunk costsand thus not relevant to the sell-or-
process further decision.
2ost and re"enue data per day for cream.
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Determine whether the company should simply sell the cream or
process it further into cottage cheese. *nalysis of whether to sell cream or process into cottage cheese.
3arais should or should not process the cream further=
2ost and re"enue data per day for skim milk.
Determine whether the company should sell the s/im mil/ or process it
further into condensed mil/.
*nalysis of whether to sell s/im mil/ or process into condensed mil/.
3arais should or should not process the mil/ further=
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+/$,%%% , and the old unit could be
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imon 1orest Corporation operates two divisions, the $imber Division and the Consumer Division.
$he $imber Division manufactures and sells logs to paper manufacturers. $he Consumer Division
operates retail lumber mills which sell a variety of products in the do-it-yourself homeowner
mar/et. $he company is considering disposing of the Consumer Division since it has been
consistently unprotable for a number of years. $he income statements for the two divisions for
the year ended December ', +))+ are presented below:
$imber Division Consumer Division $otal
ales &',()),))) &()),))) &+,))),)))
Cost of goods sold @)),))) (),))) ',+(),)))
ross prot ?)),))) '(),))) F(),)))
elling G administrative e2penses +(),))) '7),))) 4),)))
et income & (),))) &),))); & +),)))
%n the Consumer Division, F)8 of the cost of goods sold are variable costs and )8 of selling and
administrative e2penses are variable costs. $he management of the company feels it can save
&?),))) of 2ed cost of goods sold and &(),))) of 2ed selling e2penses if it discontinues
operation of the Consumer Division.
Instructionsa; Determine whether the company should discontinue operating the Consumer Division.
b; %f the company had discontinued the division for +))+, determine what net income would
have been.
a; C#H3ER D%0%%#
et %ncome
Continue Eliminate %ncrease
Decrease;
ales &()),))) &-)-
&()),)));
0ariable e2penses:
Cost of goods sold +4(,))) *; -)- +4(,)))
elling and admin. e2p. (4,))) "; -)- (4,)))
Contribution margin +)',))) -)- +)',)));
1i2ed e2penses:
Cost of goods sold ')(,))) C; 4(,))) ?),)))
elling and admin. e2p. '+?,))) D; F?,))) (),)))
et income & ),))); &'+',))); & @',)));
*; &(),))) I F)8 J &+4(,))) C; &(),))) < &+4(,))) J &')(,)))
"; &'7),))) I )8 J &(4,))) D; &'7),))) < &(4,))) J &'+?,)))
$he company should continue the Consumer Division because contribution margin, &+)',))), is
greater than the avoidable 2ed costs, &''),))).
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b; et income for the total company would have been &+(@,)))
$imber Division K Decrease in et %ncome&(),))) K &@',))); J &+(@,)))