incremental Flashcards
relevant cost
costs that will change and occur in the future
opportunity cost
the forgone or lost benefit
sunk cost
past cost (already spent $) that cannot be changed aka NOT a relevant cost
when making decisions
look @ future revenues and costs that differ
types of incremental analysis
- accept an order @ special price
- make or buy (outsource) parts
- sell or process further
- retain and replace equipment
- eliminate a product line
- allocate limited resources
when making a decision
check capacity
no change in fixed costs if
within existing capacity so fixed costs are NOT relevant
if total variable costs change
the variable costs are relevant
example of opportunity cost
allows company to use unused capacity to generate additional income
you want a
LOWER cost
incremental revenue should EXCEED
incremental costs
income should
increase
retain or replace equipment
minus salvage value when replacing equipment
eliminating a product
- consider the effect on related product lines
- fixed costs allocated to the unprofitable product must be absorbed by the other segments
- Net income may decrease when an unprofitable product is eliminated
resources can be limited
- floor space for a company
- raw material
- direct labour hours
- machine hour capacity
management must decide which products to sell to
maximize net income
relevant costs only
compare revenue and costs that change between two alternatives
if you are already at full capacity
there will be an increase in fixed costs
- bigger factory
- more machines
qualitative issue
customer loyalty
- -> will customers still pay even if there is a cheaper alternative (b/c they like your specific product better)?
- -> future sales may be affected
if you have extra capacity then special order should EXCEED
variable costs
quick glance decision
if FIXED costs will NOT change then simply just compare NEW selling price (SP) with variable cost per unit (VC)
if FIXED costs will still be there even without making more products because BELOW capacity
-depreciation
-insurance
will NOT be relevant
qualitative issue
company expansion
–> will making your own parts hamper ability to expand (opportunity cost)
qualitative issue
allocation of attention
–> main focus/purpose on the one main product now shifts attention to the other parts/items
