Differential Analysis & Pricing Decisions.  Cost Accounting. CPA Exam BAR
Channel: Farhat Lectures. The # 1 CPA & Accounting Courses
Date: 2020-09-18

In this video, I discuss differential analysis which is a cost accounting topics.  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.

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Differential analysis involves analyzing the different costs and benefits that would arise from alternative solutions to a particular problem. Relevant revenues or costs in a given situation are future revenues or costs that differ depending on the alternative course of action selected. Differential revenue is the difference in revenues between two alternatives. Differential cost or expense is the difference between the amounts of relevant costs for two alternatives.[1]

Future costs that do not differ between alternatives are irrelevant and may be ignored since they affect both alternatives similarly. Past costs, also known as sunk costs, are not relevant in decision making because they have already been incurred; therefore, these costs cannot be changed no matter which alternative is selected.

For certain decisions, revenues do not differ between alternatives. Under those circumstances, management should select the alternative with the least cost. In other situations, costs do not differ between alternatives. Accordingly, management should select the alternative that results in the largest revenue. Many times both future costs and revenues differ between alternatives. In these situations, the management should select the alternative that results in the greatest positive difference between future revenues and expenses (costs).