Question

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At times management must make decisions that involve choosing between alternative courses of action. Incremental analysis is a method that is used in the decision making process to determine the impact on income of the alternative courses of action. State five examples of common business decisions that your corporation may use incremental analysis.

Answer 1

Examples where Incremental Analysis is used to take decisions are as follows.

1. When decision is regarding Making or Buying a Component- Say a Component costs $51 if made in factory and could be purchased from outside for $49. There is an Incremental saving in cost of $2 which means component would be purchased as it increases profits.
2. When decision is about selling a product as it is or after some Further processing- Selling a product after processing it further increases Sales price of that product. Similarly its Manufacturing cost also increases. Incremental analysis shows if further processing is beneficial or not.
3. Acceptance of Offer or Special Order- Acceptance of offer requires additional Production capacity and Additional variable cost. Incremental analysis shows how much cost has increased and how much Revenue is increased. Offer is accepted if Cost increased is lower than Revenue Increased and Vice versa.
4. Eliminating a Segment or Division- Different Divisions gives different returns. Divisions have common costs allocated on them according to a predetermined rate and some fixed cost are directly associated (Unavoidable Cost) to them. Eliminating a Division also frees up Capacity and space in the company. Incremental analysis shows the benefits achieved and loss of returns on eliminating Segment.      
5. Allocation of Limiting Resources- Resources like Raw material labor hours may be Limited sometimes. Incremental analysis is used to analyze which alternative allocation is better for the benefit of the company.