CHAPTER 7

#1 What are differential revenues and costs?

Differential revenues and costs

Represent the difference in revenues and costs among alternative courses of

action. Analyzing this difference is called differential analysis. Differential analysis is
useful in making managerial decisions related to making or buying products, keeping or
dropping product lines, keeping or dropping customers, and accepting or rejecting
special customer orders.

#5 What is an avoidable cost?

Avoidable costs

Costs that can be avoided by selecting a particular course of action— are always
differential costs and must be considered when deciding between alternative courses of
action.

#8 Why are direct fixed costs typically differential costs?

Direct fixed costs

Fixed costs that can be traced directly to a product line or customer—are

differential costs and therefore pertinent to making decisions. However, we must review
these costs on a case-by-case basis because some direct fixed costs may not be
considered differential in spite of being traced directly to a product line. For example, a
five-year lease on a warehouse used solely for one product line is a direct fixed cost but
not a differential cost because the costs will continue even if the product line is
eliminated.
#9 Why are allocated fixed costs typically not differential costs?

Allocated fixed costs

Fixed costs that cannot be traced directly to a product—are

typically not differential costs. For example, if a product line is eliminated, these costs
are simply allocated to the remaining product lines.

#10 What is an opportunity cost? Why is an opportunity cost a differential cost?

Opportunity costs

Represent the potential benefits that an individual, investor, or business misses

out on when choosing one alternative over another. Because opportunity costs are
unseen by definition, they can be easily overlooked. Opportunity costs is the benefits
foregone when one alternative is selected over another which is a differential costs, and
must be included when performing differential analysis.

#20 Describe the two methods of allocating joint costs.

Physical quantities method

Allocate joint costs based on a physical measure of output.

Sales value method

Allocate joint costs based on relative sales value of each product at the split-off
point.
EXCERCISES: SET A