Question

This is Managerial Accounting class Chapter 23 – Incremental Analysis

A) What costs are considered incremental when a decision to make or buy a component/part is being considered ?

1...............................

2..............................

3..............................

4.............................

b) What type of costs are most relevant when determining whether or not to eliminate an unprofitable segment or product, Fixed costs? or Variable costs? Why?

c) When determining whether replacing an aging machine will generate cost savings, a manager should weigh the .............. with the costs savings achieved due to decreased ......................

Answer 1

Ans (A) Incremental cost is the total cost incurred due to an additional unit of product being produced. Incremental cost is calculated by analyzing the additional expenses involved in the production process, such as raw materials, for one additional unit of production.

So when component/ part is considered following are the cost which are incremental

1. Additional components cost
2. Additional maintenance cost of the component/part
3. Cost of part should not exceed the overall cost of the product
4. Additional set up cost

(B)Costs are compared for both make and buy options and the one with the lower total cost is chosen (note: there are other factors to be considered besides cost; however, for the purpose of this discussion we will assume that only the cost factor should be analyzed).

There are costs which can be changed (avoided) and costs which cannot be avoided. The first type of costs is also called relevant costs and the second type is called irrelevant costs.

Examples of relevant costs in the context of a make or buy decision include direct labor, direct materials, variable overhead. Other costs that should be considered in this category are any incremental costs necessary for a part manufacturing. For example, if a company decides to make a part internally, but this requires aa purchase of additional equipment, the cost of such equipment is relevant for the decision. In addition, sometimes making one decision or another can result in income which should be considered in the analysis; for instance, if a company decides to buy a product from a vendor and the manufacturing space frees up, it can be leased and result in income. Such income would be part of the whole make or buy decision analysis.

Examples of irrelevant costs are sunk costs (e.g., prior fixed asset acquisitions) and fixed overhead.

In making a make or buy decision, a company would compare costs under both make and buy options by considering relevant costs. Irrelevant costs would be ignored because they cannot be changed.

(C)

• Replacement cost
• Maintenance cost