Subject: Accounting For Decision Making
TY_BBA_(GEN)_Sem-VI
Unit-3 Differential Cost Analysis
(Theory and practical Examples)
Meaning & Significance of Differential Cost Analysis, Compare & Contrast between
Differential Cost Analysis and Marginal Cost Analysis. Examples based On: Level of
Activity Planning, Pricing Decision, Dumping Decision (Export Order), Acceptance of
Special offer, Make or Buy, Lease or Buy
Significance of Differential Cost Analysis:
1. The significance of these costs is obvious, since finding costs that are lower than
other alternatives can mean bigger profits for the firm. Of course, these costs are
often compared to the revenues that they reap, which are known as differential
revenues.
2. Comparing these types of costs and revenues is at the heart of what's known as a
differential cost analysis, a key tool in the decision-making process for most
successful businesses.
3. Business managers are faced every day with crucial decisions that can have
significant effects on the well-being of their firms or companies. These decisions are
often important in terms of how they impact firms financially.
4. It is impossible to do business without incurring costs along the way, but the ultimate
objective is to minimise these costs as much as possible. For that reason, business
management must be familiar with the concept of differential cost and what it means
to the bottom line.
5. Differential cost analysis is not made within the accounting records rather it is made
outside the accounting records, Differential costs may, however, be incorporatedinthe
flexible budgets because they budget costs at various levels of activity.
6. Total differential costs are considered in differential cost analysis. Cost per unit is not
taken into consideration. Total differential revenues are compared with total
differential costs before advocating an alternate course of action. A change in course
of action is recommended only if differential revenues exceed differential costs.
7. The items of cost which do not change for the alternatives under consideration are
ignored, only the difference in items of costs are considered because differential
costs analysis is concerned with changes in costs.
8. The changes in costs are measured from a common base point which may be a
present course of action or present level of production.
9. Differential cost analysis is related to the future course of action or future level of
output, so it deals with future costs. Historical costs or standard costs may be used
but they should be suitably adjusted to future conditions.
Another Difference between marginal costing and differential costing:
1. The marginal costing techniques does not consider the fixed costs at all, while
differential costing takes into account changes in fixed costs also due to changes
output.
2. Differential costing is not incorporated in the accounting records. It is used as an
analysis techn que separately, though they may be incorporated in budgets. However
marginal costs may be incorporated in the accounting system.
3. The techniques used in marginal costing are contribution approach and breakeven
analysis, while the differential costs and incremental revenue are the main
techniques of differential costing.
4. Marginal cost is based in variable costs only while differential cost may be used both
under absorption costing and marginal costing.
5. Marginal costing is concerned with short term tactical decisions while differential
costing is techniques used in long term lactical decisions making though it is useful
even for short term decision making.
6. The scope of differential costing is much wider than marginal costing.
