Chapter 13: Differential Analysis

Question 1

_______ ____ is the key to decision making.

Answer 1

Differential Analysis

Question 1

What are the 6 key concepts of decision making?

Answer 1

1. Define the alternatives being considered. (trying to see which alternative works best for us)
2. Identify relevant costs/benefits (of the alternatives being considered)
3. Apply differential analysis.
4. Ignore sunk costs.
5. Ignore future costs/benefits that do not differ between alternatives
6. Consider opportunity costs.

Question 2

a cost that has already been incurred and cannot be changed regardless of what a manager decides to do.

Answer 2

sunk cost

(these are irrelevant in the decision making process between alternatives) (so are future costs and benefits that don’t differ between alternatives)

Question 3

Focusing on the future costs and benefits that differ between the alternatives.

Answer 3

Differential Analysis

Question 4

What 4 things are included in differential analysis?

Answer 4

1. Differential costs
2. Differential revenues
3. Incremental costs
4. Avoidable costs

Question 5

Match the following definitions to which thing included in differential analysis that it describes:
1. a cost that can be eliminated by choosing one alternative over another.
2. future revenue that differs between any 2 alternatives.
3. A future cost that differs between any 2 alternatives.
4. An increase in cost between 2 alternatives.

Answer 5

1. Avoidable costs
2. Differential revenues
3. Differential costs
4. Incremental costs

Question 6

One of the most important decisions managers make is whether to ____ and ____ a business segment.

Answer 6

add; drop (ex: different locations, branches, countries, manufacturing plants, product lines, etc.)

Question 7

Ultimately, a decision to drop an old segment or add a new one is going to hinge primarily on its ______ impact. To assess this impact, it is necessary to carefully analyze the ______.

Answer 7

financial; costs

Question 8

T or F: A company should drop a segment only if its profit would increase.

Answer 8

True

(ex: Lovell digital watch. Lovell will compare the contribution margin that would be lost if the digital watch was discontinued to the fixed expenses that would be avoided if the line was discontinued)

Question 9

T or F: Depreciation of equipment is a sunk cost, and therefore should not be taken into account (aka is irrelevant) when deciding between alternatives.

Answer 9

True

Question 10

T or F: General admin expenses and general factory overhead are two fixed expenses that are irrelevant, and therefore should not be taken into account when deciding between 2 alternatives.

Answer 10

True

(aka these costs will still be there even if we add/drop a new segment or something)

Question 11

To figure out if we are at an advantage or disadvantage by dropping a segment, we should make the ______ ______ negative, and then add back the _____ _____ that can be avoided.

Answer 11

contribution margin; fixed expenses

(aka if we drop a segment, the contribution margin goes away (aka we make it negative). Then, we would ADD the fixed expenses that can be avoided to the negative contribution margin. If the outcome is still a negative, then this is a disadvantage, and we shouldn’t drop the segment. But if it’s POSITIVE, we should drop the segment)

Question 12

Sourcing Decisions:
When a company is involved in more than one activity in the entire value chain, it is _______ ______. A decision to carry out one of the activities in the value chain INTERNALLY, rather than to buy EXTERNALLY from a supplier is called a “_____ ____ _____” decision.

Answer 12

vertically integrated; “make or buy”

(aka we are looking at how we identify relevant costs/benefits associated with our sourcing decisions)

Question 13

What are the 3 advantages of Vertical Integration?

Answer 13

1. Smoother flow of parts and materials
2. Better quality control
3. Realize profits

Question 14

Vertical Integration Disadvantages:
1. Companies ay fail to take advantage of suppliers who can create ______ ____ _____ advantage by pooling demand from numerous companies.
2. While the economies of scale factor can be appealing, a company must be careful to retain control over activities that are essential to maintaining its ________ ________.

Answer 14

1. economies of scale
2. competitive position

Question 15

______ _______: are not actual cash outlays and are not recorded in the formal accounts of an organization; is the benefit that is forgone as a result of pursuing some course of action.

Answer 15

Opportunity costs

Question 16

A one-time order that is not considered part of the company’s normal ongoing business.

Answer 16

Special order

(if you want to take on a special order, it’s good for management to analyze it and see if their is a benefit to taking on that special order. It’s only going to be one time, so if you have to buy new equipment, etc., you’ll want to consider, should I take on those costs for a one-time order)

Question 17

When analyzing a special order, only the _______ ______ and ______ are relevant. Since the existing fixed manufacturing overhead costs would not be affected by the order, they are not relevant.

Answer 17

incremental costs; benefits

Question 18

Special Orders:
If the incremental revenue exceeds the incremental cost, we should (accept/reject) the order.

Answer 18

Accept!

(To figure out incremental cost, take the total variable cost, divide it by the number of units the company is currently producing/selling, and that gives you the variable cost. Then, multiply that variable cost by the amount of units asked for in the special order)

Question 19

Companies are forced to make ______ ____ ____ decisions when they do not have enough capacity to produce all of the products and sales volumes demanded by their customers.

Answer 19

volume trade off

(In these situations, companies must trade off, or sacrifice production of some products in favor of others in an effort to maximize profits)

Question 20

Key Terms and Concepts related to volume trade off decisions:
- When a limited resource of some type restricts the company’s ability to satisfy demand, the company is said to have a ________.
- The machine or process that is limiting overall output is called the ________. It is the constraint.

Answer 20

• constraint
• bottleneck

Question 21

Utilization of a Constrained Resource:
- _______ costs are usually unaffected in these situations, so the product mix that maximizes the company’s total contribution margin should ordinarily be selected.
- T or F: A company should not necessarily promote those products that have the highest unit contribution margin.
- Rather, ______ contribution margin will be maximized by promoting those products or accepting those orders that provide the highest contribution margin in relation to the constraining resource.

Answer 21

• Fixed
• True
• total

Question 22

Managing Constraints:
- It is often possible for a manager to increase the capacity of a bottleneck, which is called _______ the constraint, in numerous ways.

Answer 22

relaxing (or elevating)

Question 23

6 Ways that Management Can Increase the Capacity of a Bottleneck:
1. Working ______ on the bottleneck.
2. ______ some of the processing that would be done at the bottleneck.
3. Investing in additional _____ at the bottleneck.
4. Shifting ______ from non-bottleneck processes to the bottleneck.
5. Focusing business process _______ efforts on the bottleneck.
6. Reducing _____ _____ processed through the bottleneck.

Answer 23

1. overtime
2. Subcontracting
3. machines
4. workers
5. improvement
6. defective units

Question 24

- In some industries, two or more products, known as ______ products, are produced from a single raw material input. - The point in the manufacturing process where joint products can be recognized as a separate product is called the _____ ____ point.

Answer 24

- joint - split off (ex: in the petroleum refining industry, a large number of products are extracted from crude oil, including gasoline, jet fuel, home heating, oil, various organic chemicals, etc.)

Question 25

A decision as to whether a joint product should be sold at the split-off point or processed further is known as a ______ ___ _____ _____ decision.

Answer 25

sell or process further (aka, we can analyze whether joint products should be sold at a split-off point, or processed further)

Question 26

______ ______ are incurred up to the split-off point.

Answer 26

Joint Costs (look at pic in camera roll for example of how to solve for these types of problems)

Question 27

- Can be used to help identify potentially relevant costs for decision-making purposes. - However, managers should exercise caution against reading more into this "_______" than really exists. - People have a tendency to assume that if a cost is traceable to a segment, then the cost is automatically ______, which is UNTRUE. Before making a decision, managers must decide which of the potentially relevant costs are actually avoidable.

Answer 27

- Activity-Based Costing (ABC) - "traceability" - avoidable