Question

I am having trouble with how and determining when making the right decision of Qualitative Factors and identifying them in under the Types of Incremental Analysis?

As it says in the text, "the potential effects of the make-or-buy decision or of the decision to eliminate a line of business on existing employees and the community in which the plant is located. The cost savings that may be obtained from outsourcing or from eliminating a plant should be weighed against these qualitative attributes."

What are some examples I can go buy to get a better understanding of the different types?

Answer 1

Types of Incremental Analysis Decisions

Incremental analysis helps companies to decide whether or not to accept a special order. This special order is typically lower than its normal selling price. Incremental analysis also assists with allocating limited resources to several product lines to ensure a scarce asset is used to maximum benefit.

Decisions on whether to produce or buy goods, scrap a project, or rebuild an asset call for incremental analysis on the opportunity costs. Incremental analysis also provides insight into whether a good should continue to be produced or sold at a certain point in the manufacturing process.

Example of Incremental Analysis

As an example of incremental analysis, assume a company sells an item for $300. The company pays $125 for labor, $50 for materials, and $25 for variable overhead selling expenses.

The company also allocates $50 per item for fixed overhead costs. The company is not operating at capacity and will not be required to invest in equipment or overtime to accept a special order it receives. Then, a special order requests the purchase of 15 items for $225 each.

The sum of all variable costs and fixed costs per item is $250. However, the $50 of allocated fixed overhead costs are a sunk cost and are already spent. The company has excess capacity and should only consider the relevant costs. Therefore, the cost to produce the special order is $200 per item ($125 + $50 + $25) and the profit per item is $25 ($225 - $200).

While the company is still able to make a profit on this special order, the company must consider the ramifications of operating at full capacity. If no excess capacity is present, additional expenses to consider include investment in new fixed assets, overtime labor costs, and the opportunity cost of lost sales.