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CH 12

The document discusses differential analysis and identifying relevant costs for decision making. It explains that only costs that differ between alternatives are relevant, such as avoidable costs. Sunk costs and future costs that don't vary are irrelevant. The document provides an example of analyzing which costs are relevant to a decision about whether to drive or take the train. It concludes that the differential approach is desirable because it focuses only on information critical to the decision.

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8 views4 pages

CH 12

The document discusses differential analysis and identifying relevant costs for decision making. It explains that only costs that differ between alternatives are relevant, such as avoidable costs. Sunk costs and future costs that don't vary are irrelevant. The document provides an example of analyzing which costs are relevant to a decision about whether to drive or take the train. It concludes that the differential approach is desirable because it focuses only on information critical to the decision.

Uploaded by

sana.otaibi2002
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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CH 12: Differential Analysis

Ahmad Faleh Alwadhan


Identifying Relevant cost:

➢ Costs and benefits that differ between alternatives are relevant to in decision making.
➢ Avoidable cost:
• Costs that can be eliminated if one alternative chosen over another.
Unavoidable costs are irrelevant costs.
• Sunk cost is the cost that already incurred and can’t be avoided. Sunk cost is the
same regardless of the alternative chosen.
• Future cost is cost that do not differ between alternatives.
• After eliminating sunk cost, avoidable cost, and future costs, the costs that
remain are the differential, or avoidable, costs.

Different cost for different purpose:

➢ Costs that are relevant to one decision is not relevant to other decisions. So, managers
need information about different costs for different purposes.
Which costs and benefits are relevant in Cynthia’s decision?

• The cost of the car is a sunk cost and is not relevant to the current decision.
• The annual cost of insurance is not relevant. It will remain the same if she drives or takes
the train.
• However, the cost of gasoline is clearly relevant if she decides to drive. If she takes the
train, the cost would now be incurred, so it varies depending on the decision.
• The cost of maintenance and repairs is relevant. In the long-run these costs depend
upon miles driven.
• The monthly school parking fee is not relevant because it must be paid if Cynthia drives
or takes the train.
• At this point, we can see that some of the average cost of $0.569 per mile are relevant
and others are not.
• The decline in resale value due to additional miles is a relevant cost.
• The round-trip train fare is clearly relevant. If she drives the cost can be avoided.
• Relaxing on the train is relevant even though it is difficult to assign a dollar value to the
benefit.
• The kennel cost is not relevant because Cynthia will incur the cost if she drives or takes
the train.
• The cost of parking is relevant because it can be avoided if she takes the train.
• The benefits of having a car in New York and the problems of finding a parking space are
both relevant but are difficult to assign a dollar amount.
• From a financial standpoint, Cynthia would be better off taking the train to visit her
friend. Some of the non-financial factor may influence her final decision.

Using the differential approach is desirable because:

1. Only rarely will enough information be available to prepare detailed income statements
for both alternatives.

2. Mingling irrelevant costs with relevant costs may cause confusion and distract attention
away from the information that is really critical.

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