CB2101 Chap.10 Differential Analysis for Decisions
Differential Analysis for Decisions
Keep only future differences
Differential analysis compares alternatives using revenues, costs and opportunities that change. Sunk amounts and unavoidable allocations are excluded.
Idle capacity can make a special order attractive at a price below full cost, while scarce capacity creates an opportunity cost and requires ranking by contribution per unit of the constrained resource.
Rebuild information for the alternatives
Accounting reports contain book values, allocations and averages that serve reporting but may not change between choices.
Create two alternative columns and enter only future differences. Show every excluded amount with a reason such as sunk, unavoidable or identical.
Use one common time horizon so a short supplier quote is not compared with a multi-year internal commitment.
Evaluate make or buy from resource commitments
Internal variable cost usually belongs, but fixed overhead belongs only to the extent the decision releases the resource. Compare avoidable make cost with purchase price, freight, inspection and other supplier-specific amounts.
Add the contribution from a productive alternative use of released capacity. Quality, continuity and workforce conditions should be stated as specific thresholds rather than generic caveats.
Use capacity to frame a special order
With idle capacity, a special order contributes when incremental revenue exceeds incremental production and order-specific cost, even below full average cost.
At full capacity, include the contribution lost from regular business displaced by the order. Price, customer relationships and market separation may matter, but each condition should be linked to a cash effect or a nonfinancial constraint.
Close a segment using avoidability
Closure loses the segment's contribution margin and saves only fixed costs that disappear. Common allocations that continue are excluded.
Add companion-sales losses or an alternative capacity benefit when supported by the facts. A reported segment loss can coexist with a positive segment margin, which means closing would reduce total company profit.
Rank products by the bottleneck
When one input constrains output, divide unit contribution by scarce-resource use and allocate capacity in that order up to each product's demand.
A product with lower unit contribution can rank first if it uses far less bottleneck time. If another resource becomes binding, the one-constraint ranking is no longer sufficient and the production plan must be reconsidered.
What this chapter covers
- 01
Relevant and sunk costs
- 02
Opportunity costs
- 03
Make-or-buy choices
- 04
Special orders
- 05
Segment decisions
- 06
Constrained-resource ranking
Worked example · free
Evaluate a special order with idle capacity
- 2Find incremental contribution per unit.
- 2Compute the total effect.
- 2State the capacity condition.
Key terms
- Differential Cost
- The cost difference between two future alternatives.
- Opportunity Cost
- The benefit forgone by committing a scarce resource to one alternative.
- Constrained Resource
- A limited input that restricts output and changes the relevant product ranking.
Differential Analysis for Decisions FAQ
Why is full product cost often irrelevant to a short-run decision?
It can include sunk amounts and fixed allocations that continue under every alternative. Rebuild the comparison from future cash flows that change, then add any opportunity cost from displaced capacity.
When is a below-normal special-order price acceptable?
With idle capacity, accept financially when incremental revenue exceeds incremental production and order-specific cost. At full capacity, also include contribution lost from regular business that the order displaces.
How should products be ranked under a bottleneck?
Divide contribution margin per product unit by the scarce-resource units each product consumes. Rank by contribution per bottleneck hour, kilogram or other constrained unit, subject to demand and qualitative limits.
What should the conclusion of a differential analysis say?
Name the preferred alternative, the incremental profit effect and the decisive capacity or avoidability assumption. Then identify a concrete condition that management must verify, such as supplier quality, customer separation or the disappearance of a fixed commitment. When results are close, calculate the switching value so uncertainty is expressed as a decision boundary rather than a generic warning.
Exam move
Draw two alternative columns and annotate each figure as avoidable, unavoidable, sunk or opportunity. Use one time horizon and cross out book values or allocations that do not change. Work a make-or-buy case with avoidable supervision and a released-capacity benefit, then a special order first with idle capacity and again with displaced regular sales.
For a segment case, compare lost contribution with fixed cost genuinely avoided rather than the allocated bottom line. For constraints, circle the scarce-resource unit and place it in the denominator before ranking products, respecting demand limits. Close every solution with a decision-specific sentence and calculate the switching point for the most uncertain assumption.
Keep qualitative conditions concrete enough to verify before management acts.
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