## Unit 5 Study Guide: Differential Analysis

### 5a: Describe the purpose of differential analysis.

Differential analysis is useful in managerial decision making because it requires the manager to consider several alternatives before deciding a course of action.

• Define differential revenues and costs.
• Describe the advantages of differential analysis.

Review this decision-making process in Using Differential Analysis to Make Decisions from Managerial Accounting.

Review Figure 7.1 which presents an example of how to present a differential analysis.

Figure 7.1 Differential Analysis for Phillips Accountancy.

### 5b: Use differential analysis for make-or-buy decisions.

The goal of managerial decision making is to choose alternatives with the highest profit potential.

• Explain how differential analysis identifies avoidable costs to help managers decide whether it is more profitable to buy or manufacture a product.

Review this decision-making process in Make-or-Buy Decisions from Managerial Accounting.

Review Figure 7.2 and Figure 7.3 which present examples of differential analysis:

Figure 7.2. Make-or-Buy Differential Analysis for Best Boards, Inc.

Figure 7.3 Summary of Differential Analysis for Best Boards, Inc.

### 5c: Use differential analysis for product line decisions.

Managers use differential analysis to decide whether to keep or discontinue certain product lines.

• Explain the consideration of variable costs for making product line decisions.
• Differentiate direct fixed costs and allocated fixed costs for making product line calculations.
• Define opportunity cost and its impact on differential analysis.
• Define the consideration of sunk costs for making product line decisions.
• Know how to interpret the results of differential analysis for product line decisions.

Review this decision making process in Product Line Decisions from Managerial Accounting.

Review Figure 7.5, Figure 7.6, Figure 7.8 and Figure 7.9 which present examples of how to make product line decisions.

Figure 7.5 Income Statement for Barbecue Company

Figure 7.6 Product Line Differential Analysis for Barbecue Company

Figure 7.7 Summary of Differential Analysis for Barbecue Company

Figure 7.8 Differential Analysis with Opportunity Cost for Barbecue Company

### 5d: Use differential analysis to decide whether to keep or drop customers.

Using differential analysis to decide whether to keep a certain customer is much the same as using differential analysis to decide whether to keep certain product lines.

• Explain how to evaluate customer information during differential analysis.
• Describe four ways to measure customer profitability using activity based costing.
• Know how to interpret the results of differential analysis.

Review this decision-making process in Customer Decisions from Managerial Accounting.

Review Figure 7.9, Figure 7.10, Figure 7.11 and Figure 7.12 which present examples of how to evaluate customer profitability.

Figure 7.9 Income Statement for Colony Landscape Maintenance

Figure 7.10 Customer Differential Analysis for Colony Landscape Maintenance

Figure 7.11 Keep or Drop Customer

Figure 7.12 Summary of Differential Analysis for Colony Landscape Maintenance

### 5e: Use differential analysis for special order decisions.

Managers use differential analysis to decide whether they should accept special orders from customers.

• How do managers use differential analysis to decide whether it would be profitable to accept special orders from customers?
• List two common assumptions managers make when applying differential analysis to make decisions about special orders.

Review this decision-making process in Special Order Decisions from Managerial Accounting.

The following two tables present examples of how to evaluate special order decisions.

Figure 7.13 Special Order Differential Analysis for Tony’s T-Shirts

Figure 7.14 Summary of Differential Analysis for Tony’s T-Shirts

### 5f: Define cost terms used in differential analysis.

Using proper cost accounting terminology is important for making a differential analysis.

• Why are avoidable costs, opportunity costs, and direct fixed costs differential costs?
• Why aren't sunk costs and allocated fixed costs differential costs?

Review the cost terms used in differential analysis in Review of Cost Terms Used in Differential Analysis from Managerial Accounting.

### 5g: Describe how to use cost-plus pricing and target costing to establish prices.

It can be difficult for custom manufacturers to calculate an appropriate sales price for their custom products.

• How do manufacturers use cost-plus pricing to calculate their market price?
• Why is it difficult for manufacturers to use cost-plus pricing?
• List the four steps involved in target costing to calculate a market price.

Review cost-plus pricing and target costing in Cost-Plus Pricing and Target Costing from Managerial Accounting.

### 5h: Evaluate qualitative factors when using differential analysis.

Companies should consider qualitative factors, in addition to quantitative considerations, when they conduct a differential analysis.

• Define the terms qualitative and quantitative.
• Describe three qualitative factors managers should consider when deciding whether to outsource product production.

Review cost-plus pricing and target costing in Be Aware of Qualitative Factors from Managerial Accounting.

### Unit 5 Vocabulary

• Allocated fixed cost
• Avoidable cost
• Cost-plus pricing
• Differential analysis
• Differential cost
• Differential revenue
• Direct fixed cost
• Opportunity cost
• Product line
• Qualitative
• Quantitative
• Special order
• Sunk cost
• Target costing