Management needs data that will permit development of warning signals for products that may be in trouble. The interest payments would be tax deductible. Under those circumstances, management should select the alternative with the least cost. The problem often arises in connection with the possible use of idle equipment, idle space and even idle labour. The firm can produce 10,000 units. Before studying the applications of differential analysis, you must realize that opportunity costs are also relevant in choosing between alternatives. Answer (C) is incorrect because the Rs 1.50 unit additional cost should be included in total unit cost. Here are two examples: Example of alternative decisions. Top 10 motivating factors for organisations to go for outsourcing are : 3. Examples of Incremental Analysis Incremental analysis , sometimes called marginal or differential analysis, is used to analyze the financial information needed for decision making. Differential cost or expense is the difference between the amounts of relevant costs for two alternatives.[1]. Obtain resources not available internally. Fixed manufacturing cost amounts to Rs 17,00,000 a year whether the plant operates at 75% or 100% of capacity. Differential revenue is the difference in sales that will be generated by two different courses of action. In these situations, the management should select the alternative that results in the greatest positive difference between future revenues and expenses (costs). Example of alternative decisions. Fixed cost are relevant only if incurred to facilitate the special order. Also management should consider the investment in the training of its employees which would be lost in the event of temporary shutdown. For example, assume that the two best uses of a plot of land are as a mobile home park (annual income of $100,000) and as a golf driving range (annual income of $60,000). Example of change in output. Accordingly, in the long run, all costs (including costs classified as fixed in a given period) are relevant. Sell or Process Further Decision: The decision whether a product should be sold at the split-off point … Differential analysis involves analyzing the different costs and benefits that would arise from alternative solutions to a particular problem.Relevant revenues or costs in a given situation are future revenues or costs that differ depending on the alternative course of action selected.Differential revenue is the difference in revenues between two alternatives. Answer (d) is incorrect because the Rs 3 unit joint cost should be included in the cost of goods sold, and inventory should include the Rs 1.50 unit additional cost. To remain in business in the long run, the company must replace equipment, pay property taxes, pay administrative salaries, and so forth. Alternatively, management might accept the special order while operating at capacity if they believed there were long-term benefits associated with penetrating a new market. Whitehall Corporation produces chemicals used in the cleaning industry. The differential costs which are important in retain or replace decisions are the following: change in fixed overheads costs, loss on sale of old equipment, capital investment and related costs such as rate of return and interest. (b) Whitehall should continue to sell at split-off unless Flank offers at least Rs 4.50 per unit after further processing, which covers Whitehall’s total costs. Although an analysis of cost and revenue information may indicate that a special order would be profitable in the short run, management might still reject the order because of qualitative considerations. rust inhibitors, dust covers, security equipment, etc.). The costs she would incur at the horse stable are $100 for transportation and $50 for supplies. As a consequence, reentering the market at a latter time will probably require reeducating consumers about the company’s product. If the lease of the asset is considered an operating lease, the lease payments would be deducted from the revenue annually to arrive at pretax income. The morale of other employees, as well as company goodwill, may be adversely affected, and the recruiting and training of replacement workers that must be incurred when the facility is later reopened, add to costs. At the very least, management should insist that a cost escalation clause be added to the purchase agreement, specifying that the selling price would increase to cover any cost increases and detailing the cost computation. This method lowers the tax liability in the earlier years of the asset life than would be allowed if the company were required to depreciate the asset.
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