Managerial Accounting:
An Introduction To Concepts,
Methods, And Uses
Chapter 7
Differential Cost Analysis
for Operating Decisions
Maher, Stickney and Weil
Learning Objectives (Slide 1 of
3)

Explain the differential principle & know
how to identify costs for differential
analysis.

Explain the relation between costs &
prices.

Explain how to base target costs on
target prices.

Describe how to use differential analysis
to measure customer profitability.
Learning Objectives (Slide 2 of
3)

Explain why businesses apply
differential analysis to product choice
decisions.

Explain the theory of constraints.

Identify the factors underlying make-orbuy decisions.

Explain how to identify the costs of
producing joint products & the relevant
costs for decisions to sell or process
further.
Learning Objectives (Slide 3 of
3)

Explain the use of differential analysis to
determine when to add or drop parts of
operations

Identify the factors of inventory
management decisions.

Explain how linear programming
optimizes the use of scare resources
(Appendix 8.1)

Identify the use of the economic order
quantity model (Appendix 8.2)
Describe & Define
Differential Analysis
Differential Analysis Model
Alternative -
Status Quo =
Difference
Revenue
Revenue
Revenue
Less Variable
Costs (VC)
VC -
VC =
Change in
Revenue
Change in
VC
CM
Change in
CM
Total
Contribution
Margin (CM)
Less Fixed
Costs
Operating
Profit
CM
Change in
Fixed Costs - Fixed Costs = Fixed Costs
Change in
Profit Profit =
Profit
Differential Analysis Cont.
 A cost (or revenue) is relevant only if it
differs between alternatives under
consideration
 Focus is typically on cash flows
because:
 Cash is the medium of exchange
 Cash is a common, objective measure of
benefits and costs of alternatives
What are the three major
influences on pricing?
Review Short-Run vs. LongRun Pricing Decisions
 Time horizon of a decision is
important in determining relevant
costs in a pricing decision
 Short-run decisions include pricing for a
one-time special order
 Long-run decisions include pricing a
main product in a major market
What is the differential
approach to pricing?
Long-Run Pricing Decisions
(Slide 1 of 3)
 Define Full cost
Review the Value Chain
Long-Run Pricing Decisions
(Slide 3 of 3)
 Full cost approach is justified in
pricing decisions when:
 Entering into long-term contracts to
supply a product
 Developing and producing a customized
product
 Initially setting prices, then adjusting for
market conditions
Review Life-Cycle Product
Costing and Pricing
Explain Using Target Prices
to Set Target Costs
Explain Legal Issues
Relating Costs to Prices
Customer Profitability
 Differential analysis is useful in
determining which customers to keep
or drop
 Dropping a customer should result in
cost savings in excess of lost revenue
 Alternative uses of extra capacity
available after dropping a customer
should be included in the analysis
What are the four general
categories of customer costs?
Customer costs generally consist of the
following 4 categories of activities:
ABC provides a better understanding of
the cost of these activities
Build a Chart of Activities to
Compute Customer Costs
Comment on Decisions when
Scarce Resources are Limited
Decisions with Scarce
Resources
Define the Following
 Theory of Constraints
 Bottleneck
 Throughput Contribution
List the Five Steps to
Managing Bottlenecks
Name Three Options to
Relieve a Bottleneck
Explain Make or Buy
Decisions
Define the Following
 Split-Off Point
 Joint Costs
 Additional Processing Costs
How do you decide whether
to process further or not?
If you have any comments or suggestions concerning this
PowerPoint Presentation for Managerial Accounting, An
Introduction To Concepts, Methods, And Uses, please contact:
Dr. Michael Blue, CFE, CPA, CMA
[email protected]
Bloomsburg University of Pennsylvania