Differential analysis (also called incremental analysis) is a management accounting technique in
which we examine only the changes in revenues, costs, and profits that result from a business
decision instead of creating complete income statements for each alternative (Jan, 2019).
Decisions to make or buy, to keep or drop a product line, customer, or even take on special
orders from customers are made based on differential analysis.
The relevant revenues or costs (also called differential or incremental revenues or costs) are
revenues or costs that change depending on the alternative chosen. Unilever Nigeria Plc produces
400 products that are sold locally and globally. The company has to continuously evaluate each
product line and if it's profitable enough to keep or drop.
The relevant revenue is the sales revenue and the relevant costs are variable and direct fixed
costs that are directly linked to the product line. If we take Unilever's foods and refreshment
segment the variable costs include labor costs, equipment costs, and material costs. Labor costs
comprise wages of part-time staff, sales commission, etc. Direct fixed costs include salary,
property tax, depreciation, and interest paid on capital.
However, some fixed costs like rent that is shared by multiple product lines and will not be
reduced even if a product line is eliminated are not differential costs. These types of costs are
called allocated fixed costs. They include rent, utilities, supervisors with long-term contracts, etc.
The choice to keep or drop customers' uses similar revenues and costs as mentioned above
however, each cost is directly linked to customers rather than a product line. Consultants from
PricewaterhouseCoopers suggested another approach in which customer costs are measurable
across four categories of activities which are costs to acquire customers, cost to provide goods
and services, costs to serve customers, and cost to retain customers (Ness et al., 2001). To
accurately calculate these costs the use of Activity-based costing (ABC) is preferred.
A sunk cost is the difference between money already spent in the past, while opportunity cost is
the potential returns not earned in the future on an investment because the capital was invested
elsewhere (Fernando, 2021). Sunk costs are not considered in the differential analysis since the
choice of an alternative will have zero impact on these costs. However, opportunity costs are
considered in the differential analysis.
which we examine only the changes in revenues, costs, and profits that result from a business
decision instead of creating complete income statements for each alternative (Jan, 2019).
Decisions to make or buy, to keep or drop a product line, customer, or even take on special
orders from customers are made based on differential analysis.
The relevant revenues or costs (also called differential or incremental revenues or costs) are
revenues or costs that change depending on the alternative chosen. Unilever Nigeria Plc produces
400 products that are sold locally and globally. The company has to continuously evaluate each
product line and if it's profitable enough to keep or drop.
The relevant revenue is the sales revenue and the relevant costs are variable and direct fixed
costs that are directly linked to the product line. If we take Unilever's foods and refreshment
segment the variable costs include labor costs, equipment costs, and material costs. Labor costs
comprise wages of part-time staff, sales commission, etc. Direct fixed costs include salary,
property tax, depreciation, and interest paid on capital.
However, some fixed costs like rent that is shared by multiple product lines and will not be
reduced even if a product line is eliminated are not differential costs. These types of costs are
called allocated fixed costs. They include rent, utilities, supervisors with long-term contracts, etc.
The choice to keep or drop customers' uses similar revenues and costs as mentioned above
however, each cost is directly linked to customers rather than a product line. Consultants from
PricewaterhouseCoopers suggested another approach in which customer costs are measurable
across four categories of activities which are costs to acquire customers, cost to provide goods
and services, costs to serve customers, and cost to retain customers (Ness et al., 2001). To
accurately calculate these costs the use of Activity-based costing (ABC) is preferred.
A sunk cost is the difference between money already spent in the past, while opportunity cost is
the potential returns not earned in the future on an investment because the capital was invested
elsewhere (Fernando, 2021). Sunk costs are not considered in the differential analysis since the
choice of an alternative will have zero impact on these costs. However, opportunity costs are
considered in the differential analysis.
