Differential Costing
Differential Costing
Introduction
Costs are an important feature of many business decisions. In making decisions, it is essential to have a firm grasp of the concepts differential cost. Decisions involve choosing between alternatives. In business decisions, each alternative will have costs and benefits that must be compared to the costs and benefits of the other available alternatives. A difference in costs between any two alternatives is known as a differential cost. A difference in revenues between any two alternatives is known as differential revenue.
Differential cost is the difference between the cost of two alternative decisions, or of a change in output levels. This is a costing method that shows the difference in costs that result from different levels of activity such as making one thousand or ten thousand extra units of a product. The concept is used to reach decisions about which alternatives to pursue, and which to drop. The concept can be particularly useful in step-costing situations, where producing one additional unit of output may require a substantial additional cost. (Bragg, 2013).
A differential cost is also known as an incremental cost, although technically an incremental cost should refer only to an increase in cost from one alternative to another; decreases in cost should be referred to as decremental costs. Differential cost is a broader term, encompassing both cost increases (incremental costs) and cost decreases (decremental costs) between alternatives.
The accountant’s differential cost concept can be compared to the economist’s marginal cost concept. In speaking of changes in cost and revenue, the economist uses the terms marginal cost and marginal revenue. The revenue that can be obtained from selling one more unit of product is called marginal revenue, and the cost involved in producing one more unit of product is called marginal cost. The economist’s marginal concept is basically the same as the accountant’s differential
Introduction
Costs are an important feature of many business decisions. In making decisions, it is essential to have a firm grasp of the concepts differential cost. Decisions involve choosing between alternatives. In business decisions, each alternative will have costs and benefits that must be compared to the costs and benefits of the other available alternatives. A difference in costs between any two alternatives is known as a differential cost. A difference in revenues between any two alternatives is known as differential revenue.
Differential cost is the difference between the cost of two alternative decisions, or of a change in output levels. This is a costing method that shows the difference in costs that result from different levels of activity such as making one thousand or ten thousand extra units of a product. The concept is used to reach decisions about which alternatives to pursue, and which to drop. The concept can be particularly useful in step-costing situations, where producing one additional unit of output may require a substantial additional cost. (Bragg, 2013).
A differential cost is also known as an incremental cost, although technically an incremental cost should refer only to an increase in cost from one alternative to another; decreases in cost should be referred to as decremental costs. Differential cost is a broader term, encompassing both cost increases (incremental costs) and cost decreases (decremental costs) between alternatives.
The accountant’s differential cost concept can be compared to the economist’s marginal cost concept. In speaking of changes in cost and revenue, the economist uses the terms marginal cost and marginal revenue. The revenue that can be obtained from selling one more unit of product is called marginal revenue, and the cost involved in producing one more unit of product is called marginal cost. The economist’s marginal concept is basically the same as the accountant’s differential
References: Bragg, S (January 26,2013) What is differential cost? Accounting Tools. Retrieved February 10, 2014 from http://www.accountingtools.com/questions-and-answers/what-is-a-differential-cost.html Caplan D. (2008) Management Accounting: Concepts and Techniques. Oregon State University College of Business. Retrieved February 10, 2014 from http://www.classes.bus.oregonstate. edu Coiness, O. (January 12, 2012).Differential Cost Analysis chapter7. Retrieved February 10, 2014 http://www.slideshare.net/coiness/differential-cost-analysis-chap Martinelli, M. (September 2013) “Principles of Managerial Accounting” Retrieved February 10, 2014 http://faculty.deanza.fhda.edu/martinellimark