How is differential analysis used in deciding whether to keep or drop product lines?
Managers use differential analysis to determine whether to keep or drop a customer. The format is similar to the differential analysis format used to make product line decisions. Revenues, variable costs, and fixed costs are tracked by customer instead of by product line.
How is differential analysis used in decision-making?
Differential analysis is a decision-making technique that examines the benefits and costs associated with each of two options and compares the net results of the two. The alternative selected is the one with the most favorable (or least unfavorable) financial impact.
How is differential cost analysis helpful in decision-making?
Differential analysis is useful in this decision making because a company’s income statement does not automatically associate costs with certain products, segments, or customers. Thus, companies must reclassify costs as those that the action would change and those that it would not change.
What is the decision rule for deciding whether to drop a product line?
Decision Considerations
When deciding to add a new product line or drop an existing one, the management must consider relevant benefits and costs. As a rule, product lines or business segments should be evaluated based on traceable revenues and costs.
How do we know if we have to drop or retain a certain segment?
When deciding if a company should drop an unprofitable segment, the company should create a segment contribution margin income statement. If the contribution margin is positive, the company should consider direct and common fixed costs, what to do with freed capacity, and the effect on sales of other products.
How is differential analysis prepared?
Differential analysis (also called incremental analysis) is a management accounting technique in which we examine only the changes in revenues, costs and profits that result from a business decision instead of creating complete income statements for each alternative.
How the differential cost analysis is performed in the organization?
For the company to know if the new selling price is viable, it calculates the differential cost by deducting the cost of the current capacity from the cost of the proposed new capacity. The differential cost is then divided by the increased units of production to determine the minimum selling price.
What is the purpose of 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.
What is differential analysis and product pricing?
When applying differential analysis to pricing decisions, each possible price for a given product represents an alternative course of action. The sales revenues for each alternative and the costs that differ between alternatives are the relevant amounts in these decisions.
What are relevant and irrelevant costs and how are they used in differential analysis?
Relevant costs are costs that will be affected by a managerial decision. Irrelevant costs are those that will not change in the future when you make one decision versus another. Examples of irrelevant costs are sunk costs, committed costs, or overheads as these cannot be avoided.
What are the bases or considerations when deciding to improve or discontinue?
When deciding whether or not to discontinue a product, the decision should include the total costs, not just per-unit costs. You should review the fixed manufacturing costs, selling costs, transportation and storage costs, customer service costs and any other cost you can tie to the product.
Why do companies decide to abandon eliminate their product?
Often, the keep-versus-eliminate decision arises because the product or segment appears to be generating less of a profit than in prior periods or is unprofitable.
What rule should be followed when a manufacturer is deciding which product it should emphasize producing assuming it makes more than one product?
Managers should also include in their analysis the loss of the contribution margin from other products and departments affected by the possible discontinuing of a product. If a manufacturer sells more than one product, it should emphasize producing the product with the highest contribution margin ratio.
Which of the following should be ignored when deciding whether to sell a product as is or process it further?
Which of the following should be ignored when deciding whether to sell a product as is or process it further? explanation: The cost incurred in producing a product so far is a sunk cost that does not change with the decision and thus is an irrelevant cost.
Which of the following pieces of information would be irrelevant in deciding to upgrade a company’s heating and air conditioning system?
Which of the following pieces of information would be irrelevant when deciding to upgrade a company’s heating and air conditioning system? the purchase price of the old equipment compared to the purchase price of the new equipment.