CHAPTER 25
DIFFERENTIAL ANALYSIS, PRODUCT PRICING,
AND ACTIVITY-BASED COSTING
DISCUSSION QUESTIONS
1. a. Differential revenue is the amount of increase or decrease in revenue expected from a
particular course of action compared with an alternative.
b. Differential cost is the amount of increase or decrease in cost expected from a particular
course of action compared with an alternative.
c. Differential income is the difference between differential revenue and differential cost.
2. The differential income and costs of the lease option should be compared against selling the building.
The differential revenue would be the lease revenue compared to the proceeds from sale. The
differential expenses would be the costs associated with leasing the building, including maintenance,
property tax, and insurance, compared to the expenses of selling, such as sales commissions. The
opportunity cost of money should also be considered in the analysis.
3. If there is demand for the premium-grade product, the differential revenue (premium less commodity)
may exceed the differential cost to process the product to premium grade.
4. A business should only accept business at a special price if the lower price will not contaminate the
regular pricing for other customers or induce other customers to demand the special price. In addition,
the business must be careful not to violate the Robinson-Patman Act, which prohibits uncompetitive
price differences across different markets for the same product. Lastly, the business must consider the
longer-term ramifications of offering discount business to a customer that may wish to order in the
future.
5. It would be reasonable to purchase from the supplier if the fixed cost per unit was less than 50 cents.
That is, if the fixed cost is less than 50 cents per unit, then the variable cost per unit would exceed the
supplier’s price, making the supplier price more attractive.
6. Some of the financial considerations include the profitability of the store, including all the revenues
and the variable and fixed costs associated with the store, since they would all be differential to the
decision. In addition, any costs of closing the store and preparing the store for disposal would need
to be considered (legal costs, demolition costs, employee severance costs). Lastly, the opportunity
cost of the value of the equipment and land (either in cash or rental income) should be considered.
For example, if the opportunity value of the assets were $500 per month, then the store would need to
have a profitability exceeding this amount to remain an attractive alternative.
7. In the long run, the normal selling price must be set high enough to cover all costs (both fixed and
variable) and provide a reasonable amount for profit.
8. In setting prices, managers should also consider such factors as the prices of competing products and
the general economic conditions of the marketplace.
25-1
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, CHAPTER 25 Differential Analysis, Product Pricing, and Activity-Based
Costing
DISCUSSION QUESTIONS (Continued)
9. The target cost concept begins with a price that can be sustained in the marketplace, then
subtracts a target profit, thus determining the target cost. The cost is made to conform to the
price required in the market. In contrast, under cost plus, a markup is added to the cost. The
resulting price is assumed to be acceptable in the market.
10. The proper measure of product value in a bottlenecked process is the contribution margin per
bottleneck hour.
11. Activity-based costing should be used when a business has a combination of wide product
variety and complex production and support processes. In these circumstances, activity-based
costing will more accurately allocate factory overhead to products. This occurs because
factory overhead allocated by a single predetermined rate assumes all factory overhead is
associated with products using a single allocation base. In complex environments, however,
factory overhead may be associated with products according to how they consume activities.
Thus, multiple activity rates are needed to more closely capture how factory overhead is
actually used by products.
25-2
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, CHAPTER 25 Differential Analysis, Product Pricing, and Activity-Based
Costing
PRACTICE EXERCISES
PE 25–1A
Differential Analysis
Lease Machine (Alt. 1) or Sell Machine (Alt. 2)
January 12, 2014
Differential
Lease Sell Effect
Machine Machine on Income
(Alternative (Alternative (Alternative
1) 2) 2)
Revenues $243,000 $231,000 –$12,000
Costs –16,900 –11,550* 5,350
Income (Loss) $226,100 $219,450 –$ 6,650
* $231,000 × 5%
Jerrod Company should lease the machine.
PE 25–1B
Differential Analysis
Lease Equipment (Alt. 1) or Sell Equipment (Alt. 2)
March 23, 2014
Differential
Lease Sell Effect
Equipment Equipment on Income
(Alternative 1) (Alternative 2) (Alternative 2)
Revenues $84,600 $82,000 –$2,600
Costs –7,950 –4,920* 3,030
Income (Loss) $76,650 $77,080 $ 430
* $82,000 × 6%
Timberlake Company should sell the equipment.
25-3
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, CHAPTER 25 Differential Analysis, Product Pricing, and Activity-Based
Costing
PE 25–2A
Differential Analysis
Continue Product S (Alt. 1) or Discontinue Product S (Alt. 2)
September 12, 2014
Differential
Continue Discontinue Effect
Product S Product S on Income
(Alternative 1) (Alternative 2) (Alternative 2)
Revenue $149,000 $ 0 –$149,000
Costs:
Variable cost of goods sold –88,500 0 88,500
Variable selling and admin.
expenses –24,500 0 24,500
Fixed costs –40,000 –40,000 0
Income (Loss) –$ 4,000 –$40,000 –$ 36,000
Product S should be continued.
PE 25–2B
Differential Analysis
Continue Product B (Alt. 1) or Discontinue Product B (Alt. 2)
May 9, 2014
Differential
Continue Discontinue Effect
Product B Product B on Income
(Alternative 1) (Alternative 2) (Alternative 2)
Revenue $39,500 $ 0 –$39,500
Costs:
Variable cost of goods sold –25,500 0 25,500
Variable selling and admin.
expenses –16,500 0 16,500
Fixed costs –15,000 –$15,000 0
Income (Loss) –$17,500 –$15,000 $ 2,500
Product B should be discontinued.
25-4
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
DIFFERENTIAL ANALYSIS, PRODUCT PRICING,
AND ACTIVITY-BASED COSTING
DISCUSSION QUESTIONS
1. a. Differential revenue is the amount of increase or decrease in revenue expected from a
particular course of action compared with an alternative.
b. Differential cost is the amount of increase or decrease in cost expected from a particular
course of action compared with an alternative.
c. Differential income is the difference between differential revenue and differential cost.
2. The differential income and costs of the lease option should be compared against selling the building.
The differential revenue would be the lease revenue compared to the proceeds from sale. The
differential expenses would be the costs associated with leasing the building, including maintenance,
property tax, and insurance, compared to the expenses of selling, such as sales commissions. The
opportunity cost of money should also be considered in the analysis.
3. If there is demand for the premium-grade product, the differential revenue (premium less commodity)
may exceed the differential cost to process the product to premium grade.
4. A business should only accept business at a special price if the lower price will not contaminate the
regular pricing for other customers or induce other customers to demand the special price. In addition,
the business must be careful not to violate the Robinson-Patman Act, which prohibits uncompetitive
price differences across different markets for the same product. Lastly, the business must consider the
longer-term ramifications of offering discount business to a customer that may wish to order in the
future.
5. It would be reasonable to purchase from the supplier if the fixed cost per unit was less than 50 cents.
That is, if the fixed cost is less than 50 cents per unit, then the variable cost per unit would exceed the
supplier’s price, making the supplier price more attractive.
6. Some of the financial considerations include the profitability of the store, including all the revenues
and the variable and fixed costs associated with the store, since they would all be differential to the
decision. In addition, any costs of closing the store and preparing the store for disposal would need
to be considered (legal costs, demolition costs, employee severance costs). Lastly, the opportunity
cost of the value of the equipment and land (either in cash or rental income) should be considered.
For example, if the opportunity value of the assets were $500 per month, then the store would need to
have a profitability exceeding this amount to remain an attractive alternative.
7. In the long run, the normal selling price must be set high enough to cover all costs (both fixed and
variable) and provide a reasonable amount for profit.
8. In setting prices, managers should also consider such factors as the prices of competing products and
the general economic conditions of the marketplace.
25-1
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, CHAPTER 25 Differential Analysis, Product Pricing, and Activity-Based
Costing
DISCUSSION QUESTIONS (Continued)
9. The target cost concept begins with a price that can be sustained in the marketplace, then
subtracts a target profit, thus determining the target cost. The cost is made to conform to the
price required in the market. In contrast, under cost plus, a markup is added to the cost. The
resulting price is assumed to be acceptable in the market.
10. The proper measure of product value in a bottlenecked process is the contribution margin per
bottleneck hour.
11. Activity-based costing should be used when a business has a combination of wide product
variety and complex production and support processes. In these circumstances, activity-based
costing will more accurately allocate factory overhead to products. This occurs because
factory overhead allocated by a single predetermined rate assumes all factory overhead is
associated with products using a single allocation base. In complex environments, however,
factory overhead may be associated with products according to how they consume activities.
Thus, multiple activity rates are needed to more closely capture how factory overhead is
actually used by products.
25-2
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, CHAPTER 25 Differential Analysis, Product Pricing, and Activity-Based
Costing
PRACTICE EXERCISES
PE 25–1A
Differential Analysis
Lease Machine (Alt. 1) or Sell Machine (Alt. 2)
January 12, 2014
Differential
Lease Sell Effect
Machine Machine on Income
(Alternative (Alternative (Alternative
1) 2) 2)
Revenues $243,000 $231,000 –$12,000
Costs –16,900 –11,550* 5,350
Income (Loss) $226,100 $219,450 –$ 6,650
* $231,000 × 5%
Jerrod Company should lease the machine.
PE 25–1B
Differential Analysis
Lease Equipment (Alt. 1) or Sell Equipment (Alt. 2)
March 23, 2014
Differential
Lease Sell Effect
Equipment Equipment on Income
(Alternative 1) (Alternative 2) (Alternative 2)
Revenues $84,600 $82,000 –$2,600
Costs –7,950 –4,920* 3,030
Income (Loss) $76,650 $77,080 $ 430
* $82,000 × 6%
Timberlake Company should sell the equipment.
25-3
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
, CHAPTER 25 Differential Analysis, Product Pricing, and Activity-Based
Costing
PE 25–2A
Differential Analysis
Continue Product S (Alt. 1) or Discontinue Product S (Alt. 2)
September 12, 2014
Differential
Continue Discontinue Effect
Product S Product S on Income
(Alternative 1) (Alternative 2) (Alternative 2)
Revenue $149,000 $ 0 –$149,000
Costs:
Variable cost of goods sold –88,500 0 88,500
Variable selling and admin.
expenses –24,500 0 24,500
Fixed costs –40,000 –40,000 0
Income (Loss) –$ 4,000 –$40,000 –$ 36,000
Product S should be continued.
PE 25–2B
Differential Analysis
Continue Product B (Alt. 1) or Discontinue Product B (Alt. 2)
May 9, 2014
Differential
Continue Discontinue Effect
Product B Product B on Income
(Alternative 1) (Alternative 2) (Alternative 2)
Revenue $39,500 $ 0 –$39,500
Costs:
Variable cost of goods sold –25,500 0 25,500
Variable selling and admin.
expenses –16,500 0 16,500
Fixed costs –15,000 –$15,000 0
Income (Loss) –$17,500 –$15,000 $ 2,500
Product B should be discontinued.
25-4
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
