Module-A211-08b

WEEK 8b
INCREMENTAL ANALYSIS
Study objectives:
1. Identify the steps in management’s decision-making process.
2. Describe the concept of incremental analysis.
3. Identify the relevant costs in accepting an order at a special price.
4. Identify the relevant costs in a make-or-buy decision.
5. Identify the relevant costs in determining whether to sell or process materials
further.
6. Identify the relevant costs to be considered in retaining or replacing equipment.
7. Identify the relevant costs in deciding whether to eliminate an unprofitable
segment.
Incremental Analysis
Management’s decision-making process frequently involves the following steps:
a. Identify the problem and assign responsibility.
b. Determine and evaluate possible courses of action.
c. Make a decision.
d. Review the results of the decision.
Accounting’s contribution to the decision-making process occurs primarily in steps (b)

and (d).
Business decisions involve a choice among alternative courses of action. In making such
decisions, management ordinarily considers both financial and nonfinancial information.
The process used to identify the financial data that change under alternative courses of
action is called incremental analysis.
a. Incremental analysis involves not only identifying relevant revenues and costs,
but also determining the probable effects of the decision on future earnings.
b. Data for incremental analysis involves estimates and uncertainty.
c. Gathering data may involve market analysts, engineers, and accountants.
In incremental analysis, both costs and revenues may change. However, in some
cases (1) variable costs may not change under the alternative courses of action, and (2)
fixed costs may change.
Accept an Order at a Special Price

An order at a special price should be accepted when the incremental revenue from the
order exceeds the incremental costs.
a. It is assumed that sales in other markets will not be affected by the special order.
b. If the units can be produced within existing plant capacity, generally only variable
costs will be affected.
Make or Buy
In a make or buy decision, management must determine the costs which are different
under the two alternatives. If there is an opportunity to use the productive capacity for
another purpose, opportunity cost should be considered. Opportunity cost is the
potential benefit that may be obtained by following an alternative course of action. This
cost is an additional cost of making the component.
Sell or Process Further

The basic decision rule in a sell or process further decision is: Process further as long
ACCTG 211: Strategic Cost Management

SOUTH EAST ASIAN INSTITUTE OF TECHNOLOGY, INC. Page 1 of 2
as the incremental revenue from such processing exceeds the incremental processing
costs. Incremental revenue is the increase in sales which results from processing the
product further.
Retain or Replace Equipment
In a decision to retain or replace equipment, management compares the costs which

are affected by the two alternatives. Generally, these are variable manufacturing costs
and the cost of the new equipment.
a. The book value of the old machine is a sunk cost which does not affect the
decision. A sunk cost is a cost that cannot be changed by any present or future
decision.
b. However, any trade-in allowance or cash disposal value of the existing asset
must be considered.
Eliminate an Unprofitable Segment
In deciding whether to eliminate an unprofitable segment, management should

choose the alternative which results in the highest net income. Often fixed costs
allocated to the unprofitable segment must be absorbed by the other segments. It is
possible, therefore, for net income to decrease when what appears to be an unprofitable
segment is eliminated.
Many of the decisions involving incremental analysis also have important qualitative
features.
Sources:
Cabrera & Cabrera / Management Accounting Concepts and Application, 2017 Edition
Hilton / Managerial Accounting, 9th Edition
IMA / Standards of Ethical Conduct for Management Accountants,
https://www.accountingverse.com/managerial-accounting/introduction/code-of-ethics.html
Kieso & Waygandt / Managerial Accounting, 4th Edition
Roque, Rogelio S. / Reviewer in Management Advisory Services, 2016 Edition
End of Week 8
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PREPARE FOR A QUIZ BY NEXT MEETING.
ACCTG 211: Strategic Cost Management

SOUTH EAST ASIAN INSTITUTE OF TECHNOLOGY, INC. Page 2 of 2

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WEEK 8b

Accounting’s contribution to the decision-making process occurs primarily in steps (b)

Accept an Order at a Special Price

Sell or Process Further

ACCTG 211: Strategic Cost Management

Retain or Replace Equipment

In a decision to retain or replace equipment, management compares the costs which

Eliminate an Unprofitable Segment

In deciding whether to eliminate an unprofitable segment, management should

------------------------------------------ Nothing Follows ------------------------------------------

PREPARE FOR A QUIZ BY NEXT MEETING.

ACCTG 211: Strategic Cost Management

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