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BUS 5110 Discussion forum Unit-4

Managerial Accounting (University of the People)

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Discussion Forum Unit-4

Managerial Accounting

Differential cost analysis is the increase or decrease in total cost pf the change in specific

elements of cost that result from any variation in operations. It represents an increase or decrease

in total cost resulting out of -

1. Producing or distributing a few more or few less of the products

2. Change in the method of production or of distribution

3. An Addition or deletion of product

4. Selection of additional sales channel

In Differential analysis increase in revenues, variable costs and opportunity costs are considered.

Fixed costs and fixed portion of semi-variable costs are ignored.

Differential analysis is used:

1. Dropping or adding a product line

2. Make or buy decisions

3. Continue or shutdown product or customer etc.

Specific revenues and costs should be considered in an evaluation to drop or keep a:

1. Contribution form unprofitable product should be considered

2. Specific fixed costs of the unprofitable product shall be considered

3. Contribution from other profitable products which is proposed to be produced with the spare

capacity will be considered.

Avoidable fixed costs are considered, as these can be avoided when product or customer is shut

down. Avoidable fixed costs divided by the pv ratio will give level of sales below which it is

better to shut down.

Unavoidable fixed costs are ignored in considering in an evaluation to drop or keep. Because

these costs will be incurred even though the product or customer is discontinued.

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Shut down point = Avoidable fixed costs/PV ratio

Sunk Costs: A sunk cost is a cost that an entity has incurred, and which it can no longer recover.

Sunk costs should not be considered when making the decision to continue investing in an

ongoing project, since these costs cannot be recovered. As sunk costs are historical costs these

are incurred in the past and not relevant for decision making purpose. for example, R&D costs,

Feasibility report costs etc.

Opportunity Costs: These are considered in decision making analysis. In simple terms

opportunity cost means the loss of other alternatives when one alternative is chosen.

Costs should be considered in the differential analysis and explain why and why not:

The differential cost analysis is a useful tool for the management to know the results of any

proposed changes in the level or nature of activity. Under this method, the differential costs are

ascertained for each proposal and compared with the expected changes in revenue associated

with each proposal.

Sunk costs incurred in the past that cannot be changed by future decisions are not differential

costs because they cannot be changed by future decisions.

References

Differential Cost Analysis: Meaning and Its Practical Applications

www.yourarticlelibrary.com › cost-accounting › differential-cost-analysis

Review of Cost Terms Used in Differential Analysis

saylordotorg.github.io

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