When making decisions we consider many different scenarios before we decide the best course of action. Sometimes the decisions we make are the right one other times, well, not so much.
In accounting, some decision making is made by using Differential Analysis. In this chapter, we explore Differential Analysis and its component. This process involves analyzing the difference cost and benefits that could arise from alternative solution to a particular problem. Companies use Differential Analysis to decide different things like pricing of products; whether to accept or reject special orders; if they should stop producing or add an item to production. (Hermanson, Edwards & Ivancevich 2011) A few of the components used to carry out the decision making are:Relevant revenue/cost – these are future revenues or cost that differs depending on the alternative course of action selected.Differential revenue – this is the difference in revenue between the two alternativesDifferential cost/expenses – this is the difference between the amount of relevant cost for two alternatives.Sunk cost – this is the cost that cannot be changed no matter what alternatives is selected.Committed fixed costs – this relates to the basic facilities and organizational structure must have to continue operating.
(Hermanson et al. 2011)Another important point learned and that needs to be remembered is that when applying differential analysis, it is important to realize that two types of fixed cost exist and opportunity cost are relevant when choosing between alternatives. Those fixed costs are:Committed fixed cost – this relates to basic facilities and organizational structure that a company has to have to continue operating its business.Discretionary cost – this is the cost that can be changed, altered or eliminated completely. This changes from year to year. (Hermanson et al.
2011) After getting familiar with the components of Differential Analysis, I learned how it is applied to specific decisions like setting prices of products; accepting or rejecting special orders; adding or eliminating products, segments or customers; processing or selling joint products; and deciding whether to make a product or buy them. Hermanson used the Bart Company to show how the components of Differential Analysis works in a literal sense to give the reader a better picture. All businesses make decisions daily. How they go about choosing which decisions outweighs the other can be made easier using Differential Analysis. Using the components of Differential analysis allow an organization to look at different scenarios and which ones have the least negative effect on the company’s bottom line and which is in the best interest of the company.