DIFFERENTIAL ANALYSIS

DIFFERENTIAL ANALYSIS. TOPIC 11. abstract. CLEOFE ANNE G. GALERA.

Learning objectives. Explain the importance of differential analysis in decision making . Differentiate long term and short term pricing decisions Understand how to apply differential analysis to production decisions..

Differential analysis is a decision-making technique that examines the benefits and costs associated with each of two options and compares the net results of the two..

Short-run Vs. Long-run Pricing Decision. Short-run decisions have a time horizon of less than a year: pricing a one-time-only special order adjusting product mix and output volume.

Short-Run Pricing Decisions: Special Orders. Example: CAG now has a machine in a stand-alone kiosk where customers can bring various digital photo media and make paper prints of their pictures. The machine is usually idle about two hours each day. The art teacher at the local high school asks CAG to allow the students in the photography club to come in during idle periods to print pictures taken for a school contest. CAG has idle capacity adequate for this job, which will not affect other sales. The teacher, who has a limited budget, asks Cleofe , the CAG owner, for a special price of 40 cents a print for the 500 pictures the students have taken. The regular price is 50 cents..

2 3 4 5 6 7 8 9 10 II 12 13 Comparison of Totals Sales revenue Variable costs Total contribution Fixed costs Operating profit Alternative Presentation: Differential Analysis Differential sales, at 40C Less differential costs, 500 at 20C Differential operating profit (before taxes) Status Quo: Reject Special Order $ 2,500 (1,000) $ 1,500 (1 ,200) $ 300 c Alternative: Accept Special Order $ 2,700 (1 ,100) $ 1,600 (1 ,200) 200 100 100 Difference $ 200 $ 100.

Long-Run Pricing Decisions Most firms rely on full cost information reports when setting prices. Full cost is the total cost to produce and sell a unit; it includes all costs incurred by the activities that make up the value chain. Typically, the accounting department provides cost reports to the marketing department, which then adds appropriate markups to determine benchmark or target prices for all products the firm normally sells. This approach is often called cost-plus..

Seven additional examples will be used to illustrate how differential analysis can be applied to specific business decisions..

Make or buy a component part. Example Compu Company manufactures laptop computers and now will sell them complete with a carrying case. The company is currently operating below full capacity and has the ability to manufacture the cases. The company may usedifferential analysis to determine if it should make or buy the cases. For this differential analysis, only costs need to considerecl. selling price unit would not be affected by the and no other factors impact revenue. The following are the «)Sts of producing one carrying case in house. Direct materials Direct Fixed factory overhead S22.40 1400 Rather than manufacturing the carrying cases, the company can purchase them from an outside vendor for $34.20 each, plus a transportation cost of $3.70 per case. The following differential analysis compares the manufacturing costs unit with the costs related to purchasing the carrying case. Note that the factory overhead is fixed and would incurred under either alternative, it is not listed. Purchase price Inbound shipping charge Direct rnaterials Direct IatH)r Total cost per case Make S22.40 Differential Analysis S34.20 Difference $1.50 The cost of making the carrying case is $1.50 less than purchasing it. Compu Company should manufacture the cases..

Continue with or discontinue a product. Healthy Habits Company sells a variety snack fcx)d items. The following income statement information relates to the prcxluct line for the previous year. Cost Of sold Grrßs profit Operating LOSS from Suo, (KIO (S260,cm) It is that Of the cost Of sold amount is and Of the 01*rating exl*nses are fixed. The following differential analysis compares the cost of continuing the popcorn pruluct with the cost of discontinuing it. Note that the fixed IX)rtions Of the cost Of goods sold and would be incurred under either alternative, so they are not included. Differential Analysis Variable cost of gcxxls S360/m sold Variable operating exl* nses2 1 x 75% 2 x 6(YY0.

Lease or sell equipment. abstract. Example Company purchased equipment for $40,000 several years ago. It currently has a bCR)k value of S15,O. can sell the equipment for The company would have to pay a 2% commission on the sale. Alter-natively. the company could lease the equipment to Alden Company for $2,400 for each Of four years. At the end of the lease the company could return the equipment to its manufacturer for for scrap. In both cases, it will cost Harper Company to restore the equipment site in the factory once it is removed. Differential Analysis Scrap value Costs: Sales commission2 $2,400 x 4 2 $10,000 x.

Sell a product or process further. Example Moming Roast Coffee, Inc. produces dark roast coffee in batches of 5,000 pounds. Materials cost is S5.80 per pound. The dark roast coffee can be sold without further processing for $9.70 per pound or may be processed funher to yield dark roast decaf, which can be sold for $12.10 per pound, The processing into decaf requires additional costs of $7,480 per batch. The additional processing will also cause a 4% loss of product due to evaporation. Revenue Materials cost2 Evaporation-3 $48,500 222 $60,500 3ti480.

abstract. . Keep or replace a fixed asset. Example McNamara Company is considering selling an existing piece Of equipment for and replacing it with new equipment that will cx)St The old equipment cost and currently has accumulated depreciation of S120,O. The estimated annual variable costs for the next six years are for the old equipment and for the new equipment. Revenue Purchase price Olmating costs I Income (loss) Keep Differential Analysis Replace S75,o Difference.

Accept business at reduced price. Example Spark Top Company manufactures countertop toaster ovens and sells them for S60 unit. An Overseas wholesaler Offers to purchase 5,000 toaster ovens for $36 per unit, which would additional production what Spark Tophad planned for. The company has the capacity to process this special order. The variable manufacturing cost per unit is $25, and the fixed manufacturing cost per unit is $15. A tariff of $8(N) is charged to the company for shipping each batch of toaster ovens. Differential Analysis Reject Costs: Production costs2 Tariff Income (loss) Accept $180,000 125,000.

Capital investment analysis is a form of differential analysis used to determine whether a fixed asset should be purchased at all, or ( 2) which fixed asset among a number of choices is the best investment..

Example: A new piece of equipment that is being considered for purchase costs $90,000 and has a residual value of $10,000. It is expected to generate revenue of $75,000 over its estimated useful life of 5 years..

. Example: A new piece of equipment that is being considered for purchase costs $80,000. It is expected to generate $25,000 cash revenue each year and require cash expenditures of $5,000 to maintain..

References: https://courses.lumenlearning.com/wm-accountingformanagers/chapter/differential-analysis-process/ https://biz.libretexts.org/Bookshelves/Accounting/Book%3A_Principles_of_Managerial_Accounting_(Jonick)/09%3A_Differential_Analysis/9.01%3A_Introduction_to_Differential_Analysis#:~:text=Differential%20analysis%20is%20a%20decision,or%20least%20unfavorable)%20financial%20impact . https://www.youtube.com/watch?v=-RwHp2OFI4c&t=615s.