Differential Analysis and Product Pricing Chapter 11 Differential Analysis (slide 1 of 6) Managerial decision making involves choosing between alternative courses of action. Differential analysis, sometimes called incremental analysis, analyzes differential revenues and costs in order to determine the differential impact on profit of two alternative courses of action. Differential revenue is the amount of increase or decrease in revenue that is expected from a course of action compared to an alternative. Differential cost is the amount of increase or decrease in cost that is expected from a course of action as compared to an alternative. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 2 Differential Analysis (slide 2 of 6) Differential profit (loss) is the difference between the differential revenue and differential costs. Differential profit indicates that a decision is expected to increase income. Differential loss indicates that a decision is expected to decrease income. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 3 Differential Analysis (slide 3 of 6) The differential analysis is prepared in three columns, where positive amounts indicate the differential effect is to increase profit and income and negative amounts indicate the effect is to decrease profit and income. The first column is the revenues, costs, and profit (loss) for maintaining floor space for tables (Alternative 1). The second column is the revenues, costs, and profit (loss) for using that floor space for a salad bar (Alternative 2). The third column is the difference between the revenues, costs, and profit (loss) of two alternatives. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Differential Analysis (slide 4 of 6) The salad bar (Alternative 2) is being considered over keeping the existing tables (Alternative 1). The differential revenue of a salad bar over tables is $20,000 ($120,000 − $100,000). Because the salad bar would increase revenue and profit, it is entered as a positive $20,000 in the Differential Effects column. The differential cost of a salad bar over tables is $5,000 ($65,000 − $60,000). Because the salad bar would increase costs and decrease profit, the $5,000 is entered as a negative $(5,000) in the Differential Effects column. The differential effect of a salad bar over tables is determined by subtracting the differential costs from the differential revenues in the Differential Effects column. © 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Differential Analysis (slide 5 of 6) The differential profit of a salad bar is $15,000 ($20,000 − $5,000). Based upon the differential analysis, Bryant Re ...

1. Differential Analysis and Product Pricing
Chapter 11
Differential Analysis
(slide 1 of 6)
Managerial decision making involves choosing between
alternative courses of action.
Differential analysis, sometimes called incremental analysis,
analyzes differential revenues and costs in order to determine
the differential impact on profit of two alternative courses of
action.
Differential revenue is the amount of increase or decrease in
revenue that is expected from a course of action compared to an
alternative.
Differential cost is the amount of increase or decrease in cost
that is expected from a course of action as compared to an
alternative.
© 2020 Cengage Learning®. May not be scanned, copied or
duplicated, or posted to a publicly accessible websi te, in whole
or in part.
2
Differential Analysis
(slide 2 of 6)
Differential profit (loss) is the difference between the
differential revenue and differential costs.
Differential profit indicates that a decision is expected to

2. increase income.
Differential loss indicates that a decision is expected to
decrease income.
© 2020 Cengage Learning®. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole
or in part.
3
Differential Analysis
(slide 3 of 6)
The differential analysis is prepared in three columns, where
positive amounts indicate the differential effect is to increase
profit and income and negative amounts indicate the effect is to
decrease profit and income.
The first column is the revenues, costs, and profit (loss) for
maintaining floor space for tables (Alternative 1).
The second column is the revenues, costs, and profit (loss) for
using that floor space for a salad bar (Alternative 2).
The third column is the difference between the revenues, costs,
and profit (loss) of two alternatives.
© 2020 Cengage Learning®. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole
or in part.
Differential Analysis
(slide 4 of 6)
The salad bar (Alternative 2) is being considered over keeping
the existing tables (Alternative 1).
The differential revenue of a salad bar over tables is $20,000
($120,000 − $100,000). Because the salad bar would increase

3. revenue and profit, it is entered as a positive $20,000 in the
Differential Effects column.
The differential cost of a salad bar over tables is $5,000
($65,000 − $60,000). Because the salad bar would increase
costs and decrease profit, the $5,000 is entered as a negative
$(5,000) in the Differential Effects column.
The differential effect of a salad bar over tables is determined
by subtracting the differential costs from the differential
revenues in the Differential Effects column.
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duplicated, or posted to a publicly accessible website, in whole
or in part.
Differential Analysis
(slide 5 of 6)
The differential profit of a salad bar is $15,000 ($20,000 −
$5,000).
Based upon the differential analysis, Bryant Restaurants should
decide to replace some of its tables with a salad bar.
Doing so will increase its profit and income by $15,000.
Over time, Bryant Restaurants should review its decision based
upon actual revenues and costs.
If the actual revenues and costs differ significantly from those
shown in Slide 5, another differential analysis should be
performed.
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duplicated, or posted to a publicly accessible website, in whole
or in part.
Differential Analysis
(slide 6 of 6)

4. © 2020 Cengage Learning®. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole
or in part.
Lease or Sell
(slide 1 of 2)
Management may lease or sell a piece of equipment that is no
longer needed.
This may occur when a company changes its manufacturing
process and can no longer use the equipment in the
manufacturing process.
In making a decision, differential analysis can be used.
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duplicated, or posted to a publicly accessible website, in whole
or in part.
Lease or Sell
(slide 2 of 2)
Only the differential revenues and differential costs associated
with the lease-or-sell decision are included in the differential
analysis.
Sunk costs are costs that have been incurred in the past, cannot
be recouped, and are not relevant to future decisions.
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duplicated, or posted to a publicly accessible website, in whole
or in part.
Discontinuing a Segment or Product
A product, department, branch, territory, or other segment of a
business may be generating losses. As a result, management

5. may consider discontinuing (eliminating) the product or
segment.
Discontinuing the product or segment usually eliminates all of
the product’s or segment’s variable costs such as direct
materials, direct labor, variable factory overhead, and sales
commissions.
However, fixed costs such as depreciation, insurance, and
property taxes may not be eliminated.
Thus, it is possible for total company income to decrease rather
than increase if the unprofitable product or segment is
discontinued.
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duplicated, or posted to a publicly accessible website, in whole
or in part.
Make or Buy
Companies that manufacture products made up of components
that are assembled into a final product, such as automobile
manufacturers, must decide whether to make a part or purchase
it from a supplier.
Differential analysis can be used to decide whether to make or
buy a part.
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duplicated, or posted to a publicly accessible website, in whole
or in part.
Replace Equipment
(slide 1 of 2)
The usefulness of a fixed asset may decrease before it is worn
out.
For example, old equipment may no longer be as efficient as
new equipment.

6. Differential analysis can be used for decisions to replace fixed
assets such as equipment and machinery.
The analysis normally focuses on the costs of continuing to use
the old equipment versus replacing the equipment.
The book value of the old equipment is a sunk cost and, thus, is
irrelevant.
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duplicated, or posted to a publicly accessible website, in whole
or in part.
Replace Equipment
(slide 2 of 2)
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duplicated, or posted to a publicly accessible website, in whole
or in part.
Process or Sell
During manufacturing, a product normally progresses through
various stages or processes. In some cases, a product can be
sold at an intermediate stage of production, or it can be
processed further and then sold.
Differential analysis can be used to decide whether to sell a
product at an intermediate stage or to process it further.
In doing so, the differential revenues and costs from further
processing are compared.
The costs of producing the intermediate product do not change,
regardless of whether the intermediate product is sold or
processed further.
© 2020 Cengage Learning®. May not be scanned, copied or

7. duplicated, or posted to a publicly accessible website, in whole
or in part.
Accept Business at a Special Price
A company may be offered the opportunity to sell its products
at prices other than normal prices.
For example, an exporter may offer to sell a company’s
products overseas at special discount prices.
Differential analysis can be used to decide whether to accept
additional business at a special price.
The differential revenue from accepting the additional business
is compared to the differential costs of producing and delivering
the product to the customer.
The differential costs of accepting additional business depend
on whether the company is operating at less than capacity.
If the company is operating at less than full capacity, then the
additional production does not increase fixed manufacturing
costs.
However, selling and administrative expenses may change
because of the additional business.
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duplicated, or posted to a publicly accessible website, in whole
or in part.
Setting Normal Product Selling Prices
(slide 1 of 3)
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duplicated, or posted to a publicly accessible website, in whole
or in part.
Setting Normal Product Selling Prices

8. (slide 2 of 3)
Managers can use one of two market methods to determine
selling price.
Demand-based method
The demand-based method sets the price according to the
demand for the product.
If there is high demand for the product, then the price is set
high.
Likewise, if there is low demand for the product, then the price
is set low.
Competition-based method
The competition-based method sets the price according to the
price offered by competitors.
For example, if a competitor reduces the price, then
management adjusts the price to meet the competition.
© 2020 Cengage Learning®. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole
or in part.
Setting Normal Product Selling Prices
(slide 3 of 3)
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duplicated, or posted to a publicly accessible website, in whole
or in part.
Cost-Plus Methods
Cost-plus methods determine the normal selling price by
estimating a cost amount per unit and adding a markup,
computed as follows:
Management determines the markup based on the desired profit

9. for the product.
The markup should be sufficient to earn the desired profit plus
cover any costs and expenses that are not included in the cost
amount.
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duplicated, or posted to a publicly accessible website, in whole
or in part.
Product Cost Method
(slide 1 of 5)
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duplicated, or posted to a publicly accessible website, in whole
or in part.
Product Cost Method
(slide 2 of 5)
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duplicated, or posted to a publicly accessible website, in whole
or in part.
21
Product Cost Method
(slide 3 of 5)
The product cost method is applied using the following steps:

10. Step 1: Estimate the total product cost as follows:
Step 2: Estimate the total selling and administrative
expenses.Product costs:Direct materials $XXXDirect labor
XXXFactory overhead XXXTotal product cost $XXX
© 2020 Cengage Learning®. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole
or in part.
Product Cost Method
(slide 4 of 5)
Step 3: Divide the total product cost by the number of units
expected to be produced and sold to determine the total product
cost per unit, computed as follows:
Step 4: Compute the markup percentage as follows:
The desired profit is normally computed based on a rate of
return on assets as follows:
© 2020 Cengage Learning®. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole
or in part.

11. Product Cost Method
(slide 5 of 5)
Step 5: Determine the markup per unit by multiplying the
markup percentage times the product cost per unit as follows:
Step 6: Determine the normal selling price by adding the
markup per unit to the product cost per unit as follows:
Product cost per unit $XXXMarkup per unit XXXNormal
selling price per unit $XXX
© 2020 Cengage Learning®. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole
or in part.
Target Costing Method
(slide 1 of 2)
Target costing is a method of setting prices that combines
market-based pricing with a cost-reduction emphasis.
Under target costing, a future selling price is anticipated, using
the demand-based or the competition-based methods.
The target cost is then determined by subtracting a desired
profit from the expected selling price, computed as follows:
Target costing tries to reduce costs.
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duplicated, or posted to a publicly accessible website, in whole
or in part.
Target Cost Method

12. © 2020 Cengage Learning®. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole
or in part.
26
Target Costing Method
(slide 2 of 2)
The target cost is normally less than the current cost.
Managers must try to reduce costs from the design and
manufacture of the product.
The planned cost reduction is sometimes referred to as the cost
drift.
Costs can be reduced in a variety of ways such as the following:
Simplifying the design
Reducing the cost of direct materials
Reducing the direct labor costs
Eliminating waste
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duplicated, or posted to a publicly accessible website, in whole
or in part.
Production Bottlenecks
(slide 1 of 2)
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duplicated, or posted to a publicly accessible website, in whole
or in part.

13. Production Bottlenecks
(slide 2 of 2)
When a company has a production bottleneck in its production
process, it should attempt to maximize its profits, subject to the
production bottleneck.
In doing so, the unit contribution margin of each product per
production bottleneck constraint is used.
In a production bottleneck operation, the best measure of
profitability is the unit contribution margin per production
bottleneck constraint.
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duplicated, or posted to a publicly accessible website, in whole
or in part.
Appendix: Total Cost Method
(slide 1 of 4)
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duplicated, or posted to a publicly accessible website, in whole
or in part.
Total Cost Method
© 2020 Cengage Learning®. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole
or in part.

14. 31
Appendix: Total Cost Method
(slide 2 of 4)
The total cost method is applied using the following steps:
Step 1: Estimate the total manufacturing cost as follows:
Step 2: Estimate the total selling and administrative
expenses.Manufacturing costs: $XXXDirect materials
XXXDirect labor XXXFactory overhead XXXTotal
manufacturing cost $XXX
© 2020 Cengage Learning®. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole
or in part.
Appendix: Total Cost Method
(slide 3 of 4)
Step 3: Estimate the total cost as follows:
Step 4: Divide the total cost by the number of units expected to
be produced and sold to determine the total cost per unit, as
follows:Total manufacturing costs $XXXSelling and
administrative expenses XXXTotal cost $XXX
© 2020 Cengage Learning®. May not be scanned, copied or

15. duplicated, or posted to a publicly accessible website, in whole
or in part.
Appendix: Total Cost Method
(slide 4 of 4)
Step 5: Compute the markup percentage as follows:
The desired profit is normally computed based on a rate of
return on assets as follows:
Step 6: Determine the markup per unit by multiplying the
markup percentage times the total cost per unit as follows:
Step 7: Determine the normal selling price by adding the
markup per unit to the total cost per unit as follows:
Total cost per unit $XXXMarkup per unit XXXNormal
selling price per unit $XXX
© 2020 Cengage Learning®. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole
or in part.
Appendix: Variable Cost Method
(slide 1 of 4)
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duplicated, or posted to a publicly accessible website, in whole
or in part.

16. Variable Cost Method
© 2020 Cengage Learning®. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole
or in part.
36
Appendix: Variable Cost Method
(slide 2 of 4)
The variable cost method is applied using the following steps:
Step 1: Estimate the total variable product cost as
follows:Variable product costs:$XXXDirect materials
XXXDirect labor XXXVariable factory overhead XXXTotal
variable product cost$XXX
© 2020 Cengage Learning®. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole
or in part.
Appendix: Variable Cost Method
(slide 3 of 4)
Step 2: Estimate the total variable selling and administrative
expenses.
Step 3: Determine the total variable cost as follows:
Step 4: Compute the variable cost per unit as follows:Total
variable product cost$XXXTotal variable selling and
administrative expenses XXXTotal variable cost$XXX

17. © 2020 Cengage Learning®. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole
or in part.
Appendix: Variable Cost Method
(slide 4 of 4)
Step 5: Compute the markup percentage as follows:
The desired profit is normally computed based on a rate of
return on assets as follows:
Step 6: Determine the markup per unit by multiplying the
markup percentage times the variable cost per unit as follows:
Step 7: Determine the normal selling price by adding the
markup per unit to the variable cost per unit as follows:
Variable cost per unit$XXXMarkup per unit XXXNormal
selling price per unit$XXX
© 2020 Cengage Learning®. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole
or in part.
Yield Pricing in Service Businesses
Yield pricing is a type of “accepting business at a special price”
differential analysis.

18. © 2020 Cengage Learning®. May not be scanned, copied or
duplicated, or posted to a publicly accessible website, in whole
or in part.
Normal selling price = Cost amount per
unit + Markup
Total product cost
Product cost per unit =
Estimated units produced and sold
Desired profit + Total selling and admin
istrative expenses
Markup percentage =
Total product cost
Desired profit = Desired return × Tota
l assets
´
Markup per unit = Markup percentage P
roduct cost per unit
-
Target cost = Expected selling price
Desired profit
Total cost
Total cost per unit =
Estimated units produced and sold
Desired profit
Markup percentage =
Total cost
´
Desired profit = Desired return Tot
al assets
´
Markup per unit = Markup percentage T
otal cost per unit
Total variable cost

19. Variable cost per unit =
Estimated units produced and sold
Desired profit + Total fixed costs and
expenses
Markup percentage =
Total variable cost
Desired profit = Desired return × Tota
l assets
Markup per unit = Markup percentage ×
Variable cost per unit