Page 110 - DCOM206_COST_ACCOUNTING_II

Unit 5: Differential Costing

Questions: Notes
1. Study and analyse the case.
2. Write down the case facts.
3. What do you infer from it?

Source: http://www.gfoa.org/downloads/GFRAug04.pdf

5.3 Summary

 Differential cost is a business term that refers to the difference in costs for a business when
choosing between two alternatives.

 It is an important tool in the decision-making process for businesses looking to make
possible changes to a business model.

 Closely associated with marginal cost, a term favoured by economists, it can refer to
either fixed or variable costs. The relevance of these costs is obvious when judged alongside
of differential revenue to give businesses a perspective on the positives or negatives of a
decision.
 In any decision-making process, a choice is made between alternatives. When it comes to
the business world, those choices include costs and benefits that must be weighed in order
to assess what decision to ultimately make.

 Differential cost is the difference in costs, either negative or positive, between two or
more alternatives.
 This cost must be considered along with the difference in revenue generated by these
alternatives in order to come to a significant conclusion.
 The differential costing is based on the implication that only the relevant cost, which will
change as a result of the decision, is useful for decision-making. Any costs which are not
expected to alter, and then they are irrelevant for decision-making.

5.4 Keywords

Decremental Cost: It is used when the difference in cost is due to decrease in the level of production.

Differential Costs: The increase or decrease in total cost or the change in specific elements of cost
that result from any variations in operation is called differential cost.
Fixed Cost: Any item which remains constant whichever alternative is chosen is not a differential
cost and can be ignored in choosing alternatives.
Incremental Cost: It is used to denote differential cost when the increase in cost in due to increase
in the level of production.
Make or Buy Decision: The act of choosing between manufacturing a product in-house or
purchasing it from an external supplier.

Marginal Cost: It is defined as the sum of all variable casts.
Product Mix: Also known as product assortment, it refers to the total number of product lines
that a company offers to its customers.

Sunk Costs: Those costs which have already been incurred are irrelevant.

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