Chapter 13: Differential Analysis Flashcards
What is the second step in decision making
identify the criteria
- relevant costs and relevant benefits should be considered
- irrelevant costs and irrelevant benefits should be ignored
What is the first step in decision making
define the alternatives being considered
What is differential analysis
focusing on the future costs and benefits that differ between the alternatives
what is a differential cost
A future cost that differs between any two alternatives
What is differential revenue
future revenue that differs between two alternatives
What is an incremental cost
An increase in cost between two alternatives
What is an avoidable cost
A cost that can be eliminated by choosing one alternative over another
What are sunk costs and how should they affect differential analysis
A cost that has already been incurred and cannot be changed.
They should be ignored
What is an opportunity cost and should it be considered in decision making
It is the potential benefit that is given up when one alternative is selected over another.
Should be considered
Why is differential analysis approach desirable
- rarely will enough information be available to prepare detailed income statements for both alternatives
- Mingling irrelevant costs with relevant costs may cause confusion and distraction from critical information
What is the make or buy decision
It is the decision to carry out one of the activities in the value chain internally (make) or externally (buy) from a supplier
What does it mean for a company to be vertically integrated
It means a company is involved in more than one activity in the entire value chain
Vertical integration advantages
- Smoother flow of parts and materials
- Better quality control
- Realize profits
Vertical integration disadvantages
Companies may fail to take advantage of suppliers who can create economies of scale advantage
What are volume trade-off decisions and why do they happen
Companies must choose to sacrifice the production of some products in favor of others to maximize profits.
They happen when companies do not have the capacity to produce all of their demand
What is a constraint
A limited resource that restricts the company’s ability to satisfy demand
What is a bottleneck
A machine or process that is limiting overall output (it is a constraint)
What are joint products
two or more products produced from a single raw material input
What is the split off point
The point in the manufacturing process where joint products can be recognized as separate products
What is a sell or process decision
A decision to sell a joint product at the split-off point (Sell) or process further (process)
What are the pitfalls of allocation regarding joint costs
Allocation of joint costs is necessary for some things but should be disregarded for decision making
When is it profitable to process a joint product after the split off point
When the incremental revenue from processing exceeds the incremental processing costs
When deciding to drop or retain a segment or good what is generally relevant and irrelevant
Irrelevant:
- depreciation
- allocated fixed costs
Relevant:
- Contribution margin
- Traceable expenses
What is the factor of internal rate of return
investment required / annual cash flow
How do you calculate a profitability index
PV of cash inflows / Investment required
