Differential Analysis: The Key to Decision Making

Differential Analysis: The Key to Decision Making

1. Relevant costs/benefits & irrelevant costs/beneifts

   • Relevant costs and benefits should be considered when making decisions
   • Irrelevant costs and benefits should be ignored when making decisions

2. Differential analysis

   • Focusing on the future costs and benefits that differ between the alternatives

3. Sunk costs

   • A cost that has already been incurred and cannot be changed regardless of what a manager decides to do
   • Sunk costs are always irrelevant when choosing among alternatives

4. Opportunity cost

   • The potential benefit that is given up when one alternative is selected over another
   • Relevant costs that must be considered is every decision a manager makes

5. Make or buy decision

   • Decision whether to carry out one of the activities in the value chain internally or to buy externally from a supplier

6. Special order

   • One-time order that is not considered part of the company's normal ongoing business

7. Volume trade-off decisions

   • Comapanies must trade off, or sacrifice production of some products in favor of others in an effort to maximize profits
   • Companies are forced to make these decisions when they do not have enough capacity to produce all of the products and sales volumes demanded by their customers

8. Constraints

   • Anything that prevents you from getting more of what you want
   • Managers can increase profits by producing the products with the highest contribution margin per unit of the constrained resource
   • Managers can also increase profits by increasing the capacity of the bottleneck operation

9. Joint products

   • Two or more products that are produced from a common input

10. Adding and dropping product lines and other segments

    • Costs can be analyzed by either Cost Analysis or a Comparative format income statement
    • Managers must be careful of allocated fixed costs that may make a product line look less profitable than it really is