Incremental Analysis Lecture Notes

Introduction

• Incremental Analysis is a decision-making tool used in financial and managerial accounting.
• Focuses on the impact of decisions on revenues and costs.
• Helps in evaluating different scenarios and making informed choices.

Key Concepts

Relevant Costs and Revenues

• Only focus on costs and revenues that change as a result of the decision.
• Irrelevant Costs: Costs that do not affect the decision should be ignored.

Types of Decisions

• Make or Buy: Decide whether to produce in-house or purchase from external suppliers.
• Add or Drop: Determine whether to add or drop a product line.
• Special Orders: Assess the profitability of accepting orders below the normal selling price.

Steps in Incremental Analysis

1. Identify Alternatives: List all possible options.
2. Determine Relevant Revenues and Costs: Focus only on changes brought by each alternative.
3. Compute Net Income for Each Alternative: Compare the differences in net income.
4. Make a Decision: Choose the option with the most favorable financial impact.

Examples

• Make or Buy Decision: Compare costs of manufacturing a part in-house versus purchasing it.
• Add or Drop Decision: Evaluate the profitability of a product line by analyzing the contribution margin.

Conclusion

• Incremental Analysis simplifies complex decision-making by highlighting only relevant financial data.
• It allows managers to focus on potential changes in income rather than total amounts.

Important Considerations

• Qualitative Factors: Non-financial factors can also influence decisions (e.g., employee morale, product quality).
• Limitations: Incremental analysis may not consider the long-term implications of some decisions.