Atienza,Ma, Fenella Maxine M.

OMGT 1201
 Chapter 6: Incremental Analysis
Learning Objectives:
Identify the steps in management’s decision-making process
Describe the concept of incremental analysis.
Identify the relevant costs in accepting an order at a special price;
Identify the relevant costs in a make-or-buy decision;
Identify the relevant costs in determining whether to sell process materials further;
Identify the relevant costs to be considered in repairing, retaining, or replacing
equipment;
Identify the relevant costs in deciding whether to eliminate an unprofitable segment
or product.
Cost Accounts
- assists managers in determining which costs and
revenues are decision relevant. Cost or revenues are
relevant when they are logically related to a decision and
vary from one decision alternative to another by being
either incremental or differential.
Incremental Revenue or (differential revenue) is
the amount of revenue that differs across decision
choices; incremental cost (or differential cost) is the
amount of costs that varies across decision choices.
Example:
If the annual operating cost of an existing machine is
$30,000 and the potential replacement machine is
$22,000, the incremental annual cost to operate the
existing machine is $8,000.

($30,000 - $22,000)
The difference between the incremental revenue and the
incremental cost of a particular alternative is the incremental
profit( incremental loss) of that course of action. Management can
compare incremental effects of alternatives in deciding on the most
profitable (or least costly) alternative. Although such a comparison
sounds simple, for two reasons it is often not. First, the concept of
relevance is an inherently individualistic determination; second,
technological changes have increased the amount of available
information to consider in making a decision. One challenge is to
get as much information as possible that reflects relevant costs and
benefits.
 Oppotunity Costs represent the benefits forgone because one
course of action is chosen over another. These osts are
extremely imortant in decision making but are not included in
the accounting records.
Sunk costs are cost incured in the past to acquire an asset or a
resource.
What is Incremental Analysis?

Incremental analysis is a process that focusses only on

factors that change from one course of action or
decesion to another.
 The Outsourcing Decision
The outsourcing decision ( or make-or-buy decision) is made only
after performing an analysis that compares internal production and
opportunity costs to external purchase cost and then assesses the best
use of facilities. Having an insourcing option implies that the
company has the capacity available for that purpose or has considered
the cost of obtaining the necessary capacity, most outsourcing is not
related to an organization strategic core but to the management of
operating costs and the desire to free personnel from”drudge work”.
Thus, routine activities such as information processing are more often
outsourced than activities that constitute core competencies or new
strategies
 Benefits of Outsourcing
Strategic
*sharpen form of firm mission
*improve quality and reliability
*establish relationship and ventures with world-class partners
*create a leaner enterprise

Technological
*Reduce risk of technological obsolescence
*Leverage suppliers investment in technology
*access state of the art technology withminimal investment
 Managerial
*reduce managerial oversight responsibilities
*Leverage supplying firms expertise
* consolidate functions
*Minimize responsibility for non- core functions

Costs
*Reduce overhead costs
*Lower investment in infrastructure
*Control operating costs and structure
*Reduce training costs
 Scarce Resource Decision
Scarce resource decisions managers frequently confront the
short-run problem of making the best use of scarce recources
that are essential to production activity or service provision but
have limited availability. Scarce resources include
*maghine hours,
*skilled labor hours,
*raw materials,
*production capacity, and
*other inputs
 In long run, company management could obtain a higher quantity of a
scarce resource, such as by purchasing additional machines to increase
the number of machine hours available. However, in the short run,
management must make the most efficient use of the currently available
scarce resources
Determining the best use of scarce resources requires management to
identify company objectives. If an objective is to maximize company
profits, a scarce resources is best used to produced and sell the produce
generating the highest contributuon margin per unit of the scarce
resources. This strategy assumes that the company must ration only one
scarce resource
 Sales Mix Decision
Sales mix decisions managers continuously strive to achieve a variety of
company objectives such as maximization of profit,maintenance of or
increase in market share , adn generation of customer goodwill and
loyalty. Managers must be effective in selling product or performing
services to accomplish these objectives. Regardless of whether the
company is a retailer,manufacturer, or service organization, sales mix
refers to the relative product quantities composing a companys total
sales. Some important factors affecting a companys sales mix are
*product selling prices,
*sales force compensation,and
*advertising expenditures
Because a change in one or all of these factors could
cause sales mix to shift, managing these factors is
fundamental to managing profit.