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Incremental Analysis

Managerial Accounting

Prepared by Diane TannerUniversity of North Florida

Chapter 11

Incremental Analysis• What is it?– Analysis of relevant revenues and expenses

• Incremental = Relevant = Differential• General Rule– Only amounts which differ between

alternatives will impact the decision, so ignore all other amounts

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Incremental Analysis Components

Incremental Revenue The additional revenue as a

result of selecting one decision over another

Incremental Costs The additional costs as a

result of selecting one alternative over another

Incremental Savings The reduction of costs as a result of selecting one alternative over another

Often combined/netted

together

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Opportunity CostsThe amount given up as a

result of selecting one alternative over another

TerminologyAvoidable Cost: Amounts that can be avoided if a certain decision is madeSunk Cost: A cost that has already been incurred and is irreversibleOpportunity Cost: Represents the benefit forgone by selecting one alternative over another

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Relevant

Relevant

Not Relevant

Why Do We Use Relevant Costs?• 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

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Relevant

Not Relevant

Steps in Incremental AnalysisStep 1: Compare revenues under both alternativesStep 2: Compare costs under both alternatives

Additional costs decrease profit. Cost savings increase profit.

Step 3: List and clearly label each incremental revenue, incremental cost, incremental cost savings, and opportunity cost. Include a + sign if the incremental amount increases profit Show the amount in ( ) parentheses if the amount causes profit

to decline Step 4: Total the incremental amounts and label the effect on profit.

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Costs that do not differ between the two decisions are not relevant, so omit all irrelevant costs, including sunk costs.

7Qualitative Issues Considerations that cannot be quantified Should be considered regardless if the outcome says

to make the decision or reject the decision Some examples:

Quality of the product or component if outsourced Employee morale Ambience Perception of the community Service to customers Contribution to the 'green' environment Goodwill as a corporate citizen Safety

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The End