The differential analysis in decision making?
A differential analysis includes analyzing the costs and benefits of an alternative solution to a particular problem (Chen et al., 2010). Notably, differential expense involves calculating the difference between the expenditure of the alternatives. Also, differential revenues include finding subtracting the incomes of the alternatives. Assume the cost of a product A is 70$ while its revenue is 250$. An alternative product B expense is 40$ while its revenue is 150$. Transportation cost for both options is 10$. In this case, the shipping cost is irrelevant because it is the same.
Based on the analysis of cost and revenue of the substitute products, the best alternative would be product A.
Essentially, the differential analysis is critical in making product decisions (Chen et al., 2010). A manager may decide to scrap a product or maintain its production. Additionally, the company could provide additional features. Data acquired from differential analysis guides managers in their decision making. Information obtained from differential analysis guides managers on resource allocation (Chen et al., 2010). Administrators decide whether to allocate the limited resources to a particular venture. Moreover, managers use differential analysis in deciding whether to buy or make a particular product. In some instances making the product could be beneficial to the enterprise. Conclusively, the differential analysis is a short and efficient tool for proper management. (Chen et al., 2010)
Explain the difference between relevant and irrelevant costs by using examples.
Relevant costs include expenses incurred in one alternative and avoided in another (Lambert, 2010). Such costs affect the managerial decision in a company. Unnecessary costs do not affect administrative decisions on irrelevant expenses. Relevant costs include the variable costs of the business (Lambert, 2010). Examples of variable cost include labor and materials. Irrelevant or sunk costs include the fixed costs because they are stationary. Examples of fixed costs include insurance premiums and loans.
Adding or dropping product lines.
Adding or dropping product lines involves deciding whether to continue or discontinue a particular product line (Stapleton et al., 2004). Carefully, managers analyze the product intelligence so as to make a decision. The revenue and costs play a leading role in influencing the decision of the manager. Preferably, managers discontinue products with low returns (Stapleton et al., 2004). Other examples of relevant information include variable overhead, sales income, and direct costs. Managers should note that fixed cost does not influence adding or dropping a product. Fixed overhead costs do not change due to the elimination of the product line (Stapleton et al., 2004).
Make or buy decisions
Make or buy decision includes deciding if the firm will manufacture the product in-house or outsource from an external supplier (Stapleton et al., 2004). Qualitative data analysis plays an essential role in influencing a make or buy decision. In analyzing costs, managers look at aspects of the purchase and storage of the product. Some of the aspects of making costs include maintenance of production equipment and material cost. Similarly, buy decision cost includes transportation and tax fees. Businesses outsource due to many reasons. Some enterprises lack the necessary expertise to produce a particular product (Stapleton et al., 2004). Additionally, an entity could choose to manufacture because of quality control measures.
Sell or process further decisions
Sell or process further decision includes determining whether to sell a joint product at a particular stage or processes it further (Stapleton et al., 2004). Sometimes, manufacturers produce two or more products from the same input. An administrator decides whether to sell the product at the split-off point or to develop it further. The manager uses the incremental approach, opportunity cost and total project approach in making sell or further process decisions (Stapleton et al., 2004).
Chen, J. Z., Rees, L. L., & Sivaramakrishnan, S. (2010). On the use of accounting vs. real earnings management to meet earnings expectations-a market analysis.
Lambert, R. (2010). Discussion of â€œImplications for GAAP from an analysis of positive research in accounting.” Journal of Accounting and Economics, 50 (2), 287-295.
Stapleton, D., Pati, S., Beach, E., & Julmanichoti, P. (2004). Activity-based costing for logistics
and marketing. Business Process Management Journal, 10(5), 584-597.
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Why do we say differential analysis is the key to decision making? Explain the difference between relevant and irrelevant costs by using examples. Cover the topics: adding or dropping product lines, make or buy decisions, and sell or process further decisions.adding or dropping product lines, make or buy decisions, and sell or process further decisions.
Essentially, differential analysis is the process of comparing (Noreen, Brewer, Garrison, 2014) cost and benefits between two choices . For the process to work analyst should separate costs by they relevance. Relevance of costs can depend highly on the situation. Therefore, all costs should be analyzed in order to make the right decision. But the rule of thumb is – relevant costs are avoidable, irrelevant costs are unavoidable.
Some examples of the irrelevant costs are sunk costs. If the company needs to do the market research before deciding on which product to select, this research can be called a sunk cost (Noreen, et. al, 2014). This cost has been incurred in the past, and it was unavoidable. Therefore, we do not take it into the consideration when calculating our projectâ€s value.
Relevant costs are any expenses or profits/benefits associated with one of the alternatives. Cost of machinery for different projects can be viewed as a relevant cost. However cost of the old equipment should be irrelevant due to its nature.
Analysis as described above can help to make decisions such as adding or dropping product lines. This kind of analysis is useful when decisions should be made about some product line. Sometimes product lines decrease the overall net operating income, but they should be left because they help to increase the burden of fixed cost on other products.
Another type of problem that differential analysis can be used for is make or buy decisions. The company is deciding whether to produce details or to hire an outsourcing company to do so. It can free up some of the companiesâ€ resources as well as save money. Normally, we compare the price offered by the outsourcing company with our cost of production (Thomas, 1991).
Another application of this analysis is called sell or process. The company decides whether to sell the product in the middle of production or finish producing it and sell the product (Irfanullah).
Irfanullah, J. “Sell-or-Process-Further Decision.” Sell-or-Process-Further Decision | Example. N.p., n.d. Web. 18 Apr. 2017.
Noreen, E. W., Brewer, P. C., & Garrison, R. H. (2014). Managerial accounting for managers. New York: Mcgraw-Hill Irwin.
Thomas, M. F. (1991). A matrix approach to transfer pricing. Journal of Accounting Education, 9(1), 137-147.
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