Question

Think about the types of financial data that would be included and excluded in differential analysis. Propose which specific revenues and costs should be considered in an evaluation to drop or keep a:

• Customer
• Product line

In addition, explain sunk and opportunity costs as they relate to your selected company. Should these costs be considered in differential analysis? Why or why not?

Answer 1

1.Differential analysis is management accounting techniques in which changes in revenue, cost and Profit is consider while making business decision. Differential analysis requires to consider all the potential solution to a particular business opportunity to determine which one is the most cost effective. By analyzing the cost and revenue potential of the option accounting process can steer business in the right direction. It helps to avoid the business which seems to be profitable but carry high cost or generate less revenue. Financial data that would be included and excluded in differential analysis are

- Exclude the constant cost which does not change while considering business opportunity.

- Include relevant cost which differ between alternative while considering opportunity.

- in case where revenue is constant in different alternative, opportunity with low cost should be consider.

2. Specific revenue and cost to be considered in an evaluation to drop or keep customer product line is

- differential revenue relating to different customer product line is to be considered in evaluating whether to keep or drop product line. If revenue generated from specific product line is not profitable it should be dropped. If customer product line is profitable it should be continued.

-differential cost relating to different customer product line to be considered while evaluation. Cost directly related to product is to be evaluated. If variable cost relating to specific product line is low comparing to other opportunity then customer product line is to be continued.

3.sunk cost - sunk cost is cost that has been already incurred and cannot be recovered . Sunk cost has no effect on future and is not relevant in decision making. Sunk cost should not be considered in differential analysis as differential analysis techniques is used for future decision making and for evaluating different business opportunity. Sunk cost has no effect on decision making.

Opportunity cost - opportunity cost represent benefit that is foregone by choosing one alternative over other. Opportunity cost plays vital role in decision making and evaluating business opportunity. Opportunity cost is considered in differential analysis as these cost has ability to change the decision with respect to different business opportunity.