Among several alternatives, management opts for the most profitable one. (a) The impact on future earnings of temporarily reduction in the selling price. A company is at present working at 90% of its capacity and producing 13,500 units per annum. After answering all these questions, Terrence and Andrea went to the room and admired the beach view.
Economies of scale refers to the total cost savings a company gains due to an uptick in production. The company then calculates the estimated revenue by multiplying the expected output at a specific level by the selling price. In the above analysis, it is ascertained that the fixed overheads and a portion of semi-variable overheads remain constant for both the alternatives. Hence, they will be considered irrelevant for decision-making, as they are not affected by increase in sales volume. However, if some additional fixed costs are incurred for increased sales volume that will be considered for computation. Direct costs can be traced to a specific item or cost object.
Using the same auto manufacturer as an example, their indirect costs would be for the plant used to manufacture the cars as well as the salaries of the designers of new cars. The raw material price and the direct labor cost both make a difference, so both of these costs would be relevant as you looked at your options. What if there was no change in the direct labor needed, regardless of the cost of the raw material? If that was the case, we could disregard that option to save us time in our decision making process.
Assess what you know about differential cost in accounting with these study tools. Answer quiz questions on things like what differential cost in accounting deals with and financial considerations. On the other hand, keeping the store open until the lease expires will result in a monthly net loss of $2,000. The differential cost here is $3,000 which is computed by subtracting $2,000 from $5,000.
The amount required to purchase and remodel the building will yield 8% interest free of tax invested in good marketable securities. Statement showing the annual volume required to justify the automatic machine. The annual volume required to justify selection of the automatic machine instead of the semi-automatic machine. Extra amount to be spent (if component is purchased from the market) is Rs. 40,50,000 (i.e. 4,86,00,000 – 4,45,50,000). Therefore, the company should not purchase the component from the market and also not stop the production of the component.
Therefore, an accounting entry for this cost is not required because it is not an actual transaction. In addition, there are no accounting standards that define the treatment of differential costs (What is Differential Cost?, 2015). (ii) It is profitable for the company to increase the level of production so long as the incremental revenue is more than the differential costs. It is not advisable to https://turbo-tax.org/tax-tips-after-january-1-2021/ increase the level of production to such a level where the differential costs are more than the incremental revenue. In the given problem, the company should set the level of production at 1,50,000 units because after this level differential costs exceed the incremental revenue. The differential revenue is obtained by deducting the sales at one activity level from the sales of the previous level.
(f) Decisions such as changing the product mix, method of production, make or buy, adding new product, etc. If a decision is made on the basis of above computations, alternative 2 would be selected because it promises to generate more net operating income. As a member, you’ll also get unlimited access to over 88,000 lessons in math,
English, science, history, and more. Plus, get practice tests, quizzes, and personalized coaching to help you succeed. Differential revenue is obtained using the following formula. (f) Whether a product should be discontinued to avoid the present loss.
The concept is used when there are many possible options to do, and the selection must be made to select one option and drop the others. This concept can be particularly useful in situations related to staged costs, where the production of one additional production unit may require significant additional costs. If the offer from Middle East is accepted then 50% of the production capacity will be utilised for processing this order. The balance of 50% (i.e. 100 – 50) capacity plus 10% augmented capacity at an additional cost of Rs. 40 lacs will be available for local sales. The incremental revenue and differential costs are compared below to know whether order should be accepted or not.
A business can use differential revenue in different situations, such as when it needs to invest in a new market, decide on the product to launch first or decide on the good or service that it needs to divest. It is critical to note that when a business decides to focus on differential revenue, it ignores other factors such as income or loss. Therefore, a business cannot use differential revenue to compare the projected income to choose the best product in which to invest. Notably, costs, such as fixed costs which apply to both options, are not included since they do not distinguish one option from another.