Managerial Accounting:

An Introduction To Concepts, Methods, And Uses

Chapter 7

Differential Cost Analysis for Operating Decisions

Maher, Stickney and Weil

Learning Objectives (Slide 1 of 3)

Explain the differential principle & know how to identify costs for differential analysis.

Explain the relation between costs & prices.

Explain how to base target costs on target prices.

Describe how to use differential analysis to measure customer profitability.

Learning Objectives (Slide 2 of 3)

Explain why businesses apply differential analysis to product choice decisions.

Explain the theory of constraints.

Identify the factors underlying make-or- buy decisions.

Explain how to identify the costs of producing joint products & the relevant costs for decisions to sell or process further.

Learning Objectives (Slide 3 of 3)

Explain the use of differential analysis to determine when to add or drop parts of operations

Identify the factors of inventory management decisions.

Explain how linear programming optimizes the use of scare resources (Appendix 8.1)

Identify the use of the economic order quantity model (Appendix 8.2)

Describe & Define Differential Analysis

Differential Analysis Model

Alternative - Status Quo = Difference

Revenue Revenue Revenue Change in Revenue

Less Variable Costs (VC) VC - VC =

Change in VC

Total Contribution Margin (CM) CM CM

Change in CM

Less Fixed Costs Fixed Costs - Fixed Costs =

Change in Fixed Costs

Operating Profit Profit - Profit =

Change in Profit

Differential Analysis Cont.

A cost (or revenue) is relevant only if it differs between alternatives under consideration

Focus is typically on cash flows because:

Cash is the medium of exchange

Cash is a common, objective measure of benefits and costs of alternatives

What are the three major influences on pricing?

Review Short-Run vs. Long-Run Pricing

Decisions Time horizon of a decision is

important in determining relevant

costs in a pricing decision

Short-run decisions include pricing for a

one-time special order

Long-run decisions include pricing a

main product in a major market

What is the differential approach to pricing?

Long-Run Pricing Decisions

(Slide 1 of 3)

Define Full cost

Review the Value Chain

Long-Run Pricing Decisions

(Slide 3 of 3)

Full cost approach is justified in pricing decisions when:

Entering into long-term contracts to supply a product

Developing and producing a customized product

Initially setting prices, then adjusting for market conditions

Review Life-Cycle Product

Costing and Pricing

Explain Using Target Prices

to Set Target Costs

Explain Legal Issues Relating Costs to

Prices

Customer Profitability

Differential analysis is useful in

determining which customers to keep

or drop

Dropping a customer should result in cost

savings in excess of lost revenue

Alternative uses of extra capacity

available after dropping a customer

should be included in the analysis

What are the four general categories of customer

costs?Customer costs generally consist of the

following 4 categories of activities:

ABC provides a better understanding of the

cost of these activities

Build a Chart of Activities to Compute Customer Costs

Comment on Decisions when Scarce Resources are

Limited

Decisions with Scarce Resources

Define the Following

Theory of Constraints

Bottleneck

Throughput Contribution

List the Five Steps to Managing Bottlenecks

Name Three Options to Relieve a Bottleneck

Explain Make or Buy Decisions

Define the Following

Split-Off Point

Joint Costs

Additional Processing Costs

How do you decide whether to process

further or not?

If you have any comments or suggestions concerning this PowerPoint Presentation for Managerial Accounting, An Introduction To Concepts, Methods, And Uses, please contact:

Dr. Michael Blue, CFE, CPA, CMA blue@bloomu.edu

Bloomsburg University of Pennsylvania