Incremental

1 Analysis
Prepared By: Jebeth V. Rivera
 Incremental Analysis is a decision-making techniques used in business to
2determine the true cost difference between alternatives. Also called the relevant
cost approach, incremental analysis disregards any sunk cost. Incremental analysis
is useful in the application of making business decisions including whether to self-
produce or utilize outsourcing. Incremental analysis is a problem-solving approach
that utilizes accounting information to assist in decision making. It is applied when
more than one alternative is present.
Example

Alternative A Alternative B N/I (inc/dec)

Revenues 125,000 110,000 (15,000)

Cost 100,000 80,000 20,000

-Incremental revenue is 15,000

Net Income 25,000 30,000 5,000

-Incremental cost savings is 20,000

-Alternative B produces 5,000 more net income
 Relevant Costs is a future cash flows (inflow/outflow) that is different between the
3alternatives.
What data is relevant to a decision?
Happy Meal 1 Happy Meal 2
Coke Coke
Fries Fries
Hamburger Cheese Burger

(Hamburger & Cheese Burger are relevant data in this example)

Opportunity Cost is not really cost, its an opportunity to earn revenue, if I forgo
the opportunity to earn revenue that becomes a cost. Are the benefits lost when a
decision is made.
Ex: To attend college, some students may give up a job opportunity. An
opportunity cost of attending college is the lost wages of the foregone job
opportunity.
 Sunk Cost – historical cost, is a cost that happen in the past, its like a titanic, its
4like in the bottom of the ocean, you cannot recover anymore, its gone forever.
Ex: A machine purchase 2 years ago at a cost of 5,000 is not relevant for any
future calculation because it cannot changed.

TYPES OF INCREMENTAL ANALYSIS DECISIONS

Incremental analysis helps companies decide whether or not to accept a special

order. This special order is typically lower than its normal selling price. It also
assists with allocating limited resources among several product lines to ensure the
scarce asset is utilized to return the greatest benefit. Incremental analysis entails
decisions on whether to produce or buy goods, scrap a project or rebuild an
asset. Finally, incremental analysis provides insight into whether to produce a
good further or sell at a certain point during the manufacturing process.
1. ACCEPT an ORDER at a SPECIAL PRICE/ORDER
5 Ex: Sunbelt Company produces 100,000 blenders per month, which is
80% of plant capacity. Variable manufacturing cost are 400,000 or 4 per unit. The
blenders are normally sold directly to retailers for 20 each. Sunbelt has an offer
from Kensington Company for special order of 2,000 units at 11 per unit.
Acceptance of the offer would not affect normal sales of the product, and
additional units can be manufactured without increasing plant capacity. What
should management do?
Analysis:

Reject Accept N/I (Inc./Dec.)

Revenues 0 22,000 22,000

Cost 0 8,000 8,000

Net Income 0 14,000 14,000

(Decision: the management should ACCEPT the special order to earned a 14,000
additional income)
Computation:
6 Revenue = Sales price X unit produce (11*2,000)
Cost = Variable cost/unit X unit produce (4*2,000)

2. MAKE OR BUY
Ex: Baron Company incurs the following annual costs in producing
25,000 ignition switches for motor scooters.
DM – 50,000
DL – 75,000
VOH - 40,000
FOH – 60,000
TMC is 225,000 or 9.00 cost/unit
Instead of making its own switches, Baron Company might purchase the
ignition switches at a price of 8.00. What should management do?
Analysis:
7
Make Buy N/I (inc./dec.)

DM 50,000 0 50,000

DL 75,000 0 75,000

VOH 40,000 0 40,000

FOH 60,000 60,000 0

Purchase Price 200,000 (200,000)

Total Anuual Cost 225,000 260,000 (35,000)

(Decision: the management should MAKE or produce ignition switches rather than
Buy it, because annual cost is lesser than 35,000)

Computation:
Purchase Price = Sales price X unit produce (8*25,000)
3. EQUIPMENT REPLACEMENT DECISIONS
8 Ex: The Wheel Deal Corp. makes customs wheel cars. One machine that
is used in its operation is an automated drill press. The management of Wheel Deal
is considering purchasing a new automated drill press that costs less to operate.
The new automated drill press has the following data:
New automated drill press purchased price – 230,000
Annual yearly cost savings – 50,000
Life of machine – 5 years
The old automated drill press has the following data:
Old automated drill press original cost – 360,000
Old automated drill press current value – 20,000
Old automated drill press remaining life – 5 years
Should the new automated drill press be purchased?
Analysis:
9
Replace
Purchase (230,000)
Cost savingss 250,000
Sale of old machine 20,000
Total 40,000
(Decision: Yes, the Company would be 40,000 better off)

Computation:
Cost savings = annual yearly cost savings* life of machine
= 50,000*5
= 250,000
 Exercises:
101. The Breeze Days Corp. makes small decorative windmills. These windmills
have the following pricing and cost structure.
Selling Price – 20.00
Variable cost/unit – 13.00
Fixed cost/unit – 3.00
The regular production is 20,000 units per month. The maximum number of
windmills that can be produced in the plant is 32,000 per month. A foreign
company has asked for a special order of 5,000 units at a price of 15.00 per unit.
Should Breeze Days Corp. accept the special order?

2. The Oregon Corp. makes specialty wooden pens. These pens have the following
pricing and cost structure.
Selling Price – 7.00
Variable cost/unit – 3.50
Fixed cost/unit – 1.75
 Exercises:
11 The regular production is 8,000 units per month. The maximum number of
pens that can be produced in the plant is 10,000 per month. A foreign Company
asked for a special order of 1,000 units at a price of 6.00 per unit. An additional
1.00 per unit will be incurred if the special order is accepted. Should Oregon
accept the special order?

3. The ABC Corp. makes small statues out of granite. These statues have the
following pricing and cost structure.
Selling Price – 15.00
DM per unit – 4.00
DL per unit – 1.80
VOH per unit – 1.20
FOH per unit – 1.00
Variable Selling Expense per unit – 1.50
 Exercises:
12 A foreign Company asked for a special order of 500 units at a price of 10.00
per unit. ABC has an excess capacity to complete the special order without
impacting regular production. No selling expense will be incurred for the special
order. Should ABC accept the special order

4. The Motor Company makes steering wheel covers for cars. These steering wheel
covers have the following cost structure:
Units produced – 5,000
Variable cost/unit – 12.00
Fixed cost/unit – 4.00
The Auto Fun company has offered to make the steering wheel covers for
15.00 each. If the offer is accepted the variable costs will be eliminated, but the
fixed costs will remain. Should Motor Company accept the offer? How many
additional income will be realized by taking the offer?
 Exercises:
135. The Cooper Corp. makes furniture. One of Cooper’s divisions makes lounge
chairs. The lounge chair division has the following cost structure:
Total Units produced – 10,000
Total DM – 100,000
Total DL – 60,000
Total VOH – 40,000
Total allocated FOH – 55,000
The Drake Corp. has offered to make the lounge chairs for Cooper for 18.00
each. If the offer is accepted the allocated fixed OH will have to be re-allocated to
other divisions. Should Cooper accept the offer.
 Exercises:
14
6. The Dart Consulting Firm uses a large scanner to digitize their clients data. Dart
is considering the updating the scanner with a new one. The scanners have the
following estimated data.

Old Scanner New Scanner

Cost 140,000 120,000

Annual Operating Costs 55,000 15,000

Remaining useful life 5 years 5 years

Current value 38,000

Should the scanner be purchased

 Exercises:
157. Jeffcoat Company is considering replacing a factory machine with a new
machine. Jeffcoat Company has a factory machine that originally cost 110,000. It
has a balance in Accumulated Depreciation of 70,000, so its book value is 40,000.
It has a remaining useful life of 4 years. The Company is considering replacing the
machine with a new machine.
A new machine is available that costs 120,000. It is expected to have a zero
salvage value at the end of its 4-year useful life. If the new machine is acquired,
operating cost are expected to decrease from 160,000 to 125,000, and the old unit
could be sold for 5,000. Prepare the incremental analysis for the 4-year period.
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