COMM305 Final Exam Study | Verified study complete Solutions |
A+ Graded | 2026 Updates | 100% correct
Chapter 7 – Incremental Analysis
Describe management’s decisionmaking process and the concept of
incremental analysis
Management’s DecisionMaking Process
• Does not always follow a set pattern or process o
Decisions vary in scope
o Decisions vary in urgency and importance
However, some steps can be identified:
• Considers both financial and nonfinancial
information o Financial information
Revenues and costs
Overall profitability o Nonfinancial information
Effect of decision on employee turnover (how employees feel
at work)
Environment
Overall image of company
Incremental Analysis Approach
• Decisions involve a choice among alternative actions
• Basically bout making a decision
• Financial data relevant to a decision are the data that vary in the future among
alternatives o Both costs and revenues may vary, or o Only revenues may vary, or
o Only costs may vary
• Incremental Analysis: Process to identify financial data that change under alternative
actions o Identifies probable effects of decisions on future earnings
,Basic approach in Incremental Analysis income
Net Income or (incremental change)
Alternative Alternative B
A (15,000) $ A
Revenues 125,000$ 110,000$ 20,000 l
Costs 100,000 80,000 Net 25,000$ 5,000$ t e
30,000$ r
native B is being compared to Alternative A o Incremental
revenue is $15,000 less under Alternative B o Incremental
cost savings of $20,000 is realized
o Why would you choose alternative A? to have a higher revenue at the
beginning??? NO
o Alternative B produces $5,000 more net income
Key cost concepts in incremental analysis
• Relevant cost: In incremental analysis, the only factors to be considered are: (1) those
costs and revenues that are different for each alternative (usually why fixed costs are
irrelevant), and (2) those costs and revenues that will occur in the future (why sunk
costs are irrelevant) o Look between your relevant revenues & costs = Anything that
varies between both options (don’t care about the number that does not change)
(present & LT)
• Opportunity cost: In choosing to take one action, the company must often give up the
opportunity to benefit from some other action o Benefit given up to pursue
alternative
• Sunk cost: Costs that have already been incurred and will not be changed or avoided by
any future decision.
Types of Incremental Analysis
Accept an Order at a Special Price
• Obtain additional business by making price concessions
• Assumes sales of the products in other markets would not be affected by special order o
Nobody finds out that you got a special price from WaltMart (other are not jealous of
this offer)
• Assumes company is not operating at full capacity
• Consider additional fixed costs
• Example: regular price = 10$, a customer offers you to buy a large quantity of 30,000
and wants a reduced price of 8$... should you accept?
o Are you at capacity?
If yes = I am producing at my maximum (no idle inventory) REJECT THE
OFFER (because means that you are selling everything you can, so why
, would you sell it a reduced price instead of selling it to people at full
price)
If not consider
Example: a client offers you to buy 30,000 units at 8$ (instead of 10$)
Scenario 1 Scenario 2
Max capacity 100,000 Max capacity 100,000
Current 60,000 Current 80,000
Excess 40,000 Excess 20,000
SP 8 ** can 20,000 units + 10,000 units from
VC (7) current selling (should you do it?)
CM 1 1$ 30,000 = 30,000$ (ACCEPT)
30,000 VC (7) = 210,000
10,000 CM (3) = 30,000
240,000
3,000 8 = 240,000 (indifferent because can
cover your FC if higher , if lower ) Opportunity cost = contribution margin of sales that you
give up 10 – 7 = 3
Example:
Customer offers to buy a special order of 2,000 blenders at $11 per unit from Sunbelt.
o No effect on normal sales; sufficient plant capacity o Operating at
80% capacity = 100,000 units
o Current fixed manufacturing costs = $400,000 or $4 per unit
Whether you accept the order or not you will have to pay FC (so should you accept
the order even if your total cost of (8 + 4) 12$ are higher than 11$?) o Variable
manufacturing cost = $8 per unit o Normal selling price = $20 per unit What Should the
management do?
Reject Order Accept Order Incremental Revenue and Costs
Revenues 0$ 11 2,000 22,000$
= 22,000$
Costs 0$ 8 2,000 16,000$
= 16,000$
Net 0$ 6,000$ 6,000$
Income
, Based strictly on total cost of $12 per unit ($8 + $4), reject offer as cost exceeds selling
price of $11
Only total variable costs change – thus they are relevant
No change in fixed costs since within existing capacity – thus fixed costs are not
relevant
Decision: Accept the offer. Income will increase by $6,000.
Make or Buy
• Outsourcing: The decision to buy parts or services rather than making them
• Savings in fixed costs
• Benefits of freeing up machine (ex. could also produce car wheels)
Example:
Baron Co. incurs the following costs to make 25,000 switches:
Direct Materials 50,000$
Direct Labour 75,000
Variable manufacturing overhead 40,000
Fixed manufacturing overhead 60,000
Total manufacturing costs 225,000$ Total cost per
unit (225,000 ÷ 25,000) 9,00$/ unit
If outsource, will eliminates all variable costs and $10,000 of fixed costs; however,
$50,000 of fixed costs remain
Make Buy Net Income Increase (Decrease)
Direct materials 50,000$ 0$ 50,000$
Direct Labour 75,000$ 0$ 75,000
Variable manufacturing costs 40,000 0$ 40,000
Fixed manufacturing costs 60,000 50,000 10,000
Purchasing price (25,000 0$ 200,000 (200,000)
8$)
Total annual cost 225,000 250,000$ (25,000$)
Based on analysis of costs under both alternatives: Purchasing adds $25,000 to cost of
switches
Decision: Continue to make switches.
Opportunity Cost
A+ Graded | 2026 Updates | 100% correct
Chapter 7 – Incremental Analysis
Describe management’s decisionmaking process and the concept of
incremental analysis
Management’s DecisionMaking Process
• Does not always follow a set pattern or process o
Decisions vary in scope
o Decisions vary in urgency and importance
However, some steps can be identified:
• Considers both financial and nonfinancial
information o Financial information
Revenues and costs
Overall profitability o Nonfinancial information
Effect of decision on employee turnover (how employees feel
at work)
Environment
Overall image of company
Incremental Analysis Approach
• Decisions involve a choice among alternative actions
• Basically bout making a decision
• Financial data relevant to a decision are the data that vary in the future among
alternatives o Both costs and revenues may vary, or o Only revenues may vary, or
o Only costs may vary
• Incremental Analysis: Process to identify financial data that change under alternative
actions o Identifies probable effects of decisions on future earnings
,Basic approach in Incremental Analysis income
Net Income or (incremental change)
Alternative Alternative B
A (15,000) $ A
Revenues 125,000$ 110,000$ 20,000 l
Costs 100,000 80,000 Net 25,000$ 5,000$ t e
30,000$ r
native B is being compared to Alternative A o Incremental
revenue is $15,000 less under Alternative B o Incremental
cost savings of $20,000 is realized
o Why would you choose alternative A? to have a higher revenue at the
beginning??? NO
o Alternative B produces $5,000 more net income
Key cost concepts in incremental analysis
• Relevant cost: In incremental analysis, the only factors to be considered are: (1) those
costs and revenues that are different for each alternative (usually why fixed costs are
irrelevant), and (2) those costs and revenues that will occur in the future (why sunk
costs are irrelevant) o Look between your relevant revenues & costs = Anything that
varies between both options (don’t care about the number that does not change)
(present & LT)
• Opportunity cost: In choosing to take one action, the company must often give up the
opportunity to benefit from some other action o Benefit given up to pursue
alternative
• Sunk cost: Costs that have already been incurred and will not be changed or avoided by
any future decision.
Types of Incremental Analysis
Accept an Order at a Special Price
• Obtain additional business by making price concessions
• Assumes sales of the products in other markets would not be affected by special order o
Nobody finds out that you got a special price from WaltMart (other are not jealous of
this offer)
• Assumes company is not operating at full capacity
• Consider additional fixed costs
• Example: regular price = 10$, a customer offers you to buy a large quantity of 30,000
and wants a reduced price of 8$... should you accept?
o Are you at capacity?
If yes = I am producing at my maximum (no idle inventory) REJECT THE
OFFER (because means that you are selling everything you can, so why
, would you sell it a reduced price instead of selling it to people at full
price)
If not consider
Example: a client offers you to buy 30,000 units at 8$ (instead of 10$)
Scenario 1 Scenario 2
Max capacity 100,000 Max capacity 100,000
Current 60,000 Current 80,000
Excess 40,000 Excess 20,000
SP 8 ** can 20,000 units + 10,000 units from
VC (7) current selling (should you do it?)
CM 1 1$ 30,000 = 30,000$ (ACCEPT)
30,000 VC (7) = 210,000
10,000 CM (3) = 30,000
240,000
3,000 8 = 240,000 (indifferent because can
cover your FC if higher , if lower ) Opportunity cost = contribution margin of sales that you
give up 10 – 7 = 3
Example:
Customer offers to buy a special order of 2,000 blenders at $11 per unit from Sunbelt.
o No effect on normal sales; sufficient plant capacity o Operating at
80% capacity = 100,000 units
o Current fixed manufacturing costs = $400,000 or $4 per unit
Whether you accept the order or not you will have to pay FC (so should you accept
the order even if your total cost of (8 + 4) 12$ are higher than 11$?) o Variable
manufacturing cost = $8 per unit o Normal selling price = $20 per unit What Should the
management do?
Reject Order Accept Order Incremental Revenue and Costs
Revenues 0$ 11 2,000 22,000$
= 22,000$
Costs 0$ 8 2,000 16,000$
= 16,000$
Net 0$ 6,000$ 6,000$
Income
, Based strictly on total cost of $12 per unit ($8 + $4), reject offer as cost exceeds selling
price of $11
Only total variable costs change – thus they are relevant
No change in fixed costs since within existing capacity – thus fixed costs are not
relevant
Decision: Accept the offer. Income will increase by $6,000.
Make or Buy
• Outsourcing: The decision to buy parts or services rather than making them
• Savings in fixed costs
• Benefits of freeing up machine (ex. could also produce car wheels)
Example:
Baron Co. incurs the following costs to make 25,000 switches:
Direct Materials 50,000$
Direct Labour 75,000
Variable manufacturing overhead 40,000
Fixed manufacturing overhead 60,000
Total manufacturing costs 225,000$ Total cost per
unit (225,000 ÷ 25,000) 9,00$/ unit
If outsource, will eliminates all variable costs and $10,000 of fixed costs; however,
$50,000 of fixed costs remain
Make Buy Net Income Increase (Decrease)
Direct materials 50,000$ 0$ 50,000$
Direct Labour 75,000$ 0$ 75,000
Variable manufacturing costs 40,000 0$ 40,000
Fixed manufacturing costs 60,000 50,000 10,000
Purchasing price (25,000 0$ 200,000 (200,000)
8$)
Total annual cost 225,000 250,000$ (25,000$)
Based on analysis of costs under both alternatives: Purchasing adds $25,000 to cost of
switches
Decision: Continue to make switches.
Opportunity Cost
