{"id":565,"date":"2018-04-18T22:47:10","date_gmt":"2018-04-18T22:47:10","guid":{"rendered":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/?post_type=chapter&#038;p=565"},"modified":"2024-04-29T17:25:15","modified_gmt":"2024-04-29T17:25:15","slug":"differential-cost","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/chapter\/differential-cost\/","title":{"raw":"Differential Cost","rendered":"Differential Cost"},"content":{"raw":"<div class=\"textbox learning-objectives\">\r\n<h3>Learning Outcomes<\/h3>\r\n<ul>\r\n \t<li>Define differential cost<\/li>\r\n<\/ul>\r\n<\/div>\r\nManagers have a multitude of decisions to make. Which product to make, how much to sell it for, to make or buy raw materials and components, how and where to distribute the product and so forth. Each of the decisions has at least two options.\r\n\r\nWhen we work to make decisions, we need to look at the pros and cons of each option. The key to making these decisions is called differential analysis-focusing on the pros and cons (costs and benefits) that <strong>differ<\/strong> between the two options.\r\n\r\nDifferential cost can then be defined as the difference in cost between any two alternative choices.\r\n\r\n<iframe src=\"\/\/plugin.3playmedia.com\/show?mf=4309241&amp;p3sdk_version=1.10.1&amp;p=20361&amp;pt=375&amp;video_id=-IhNuUIGce4&amp;video_target=tpm-plugin-2cf7a52l--IhNuUIGce4\" width=\"800px\" height=\"450px\" frameborder=\"0\" marginwidth=\"0px\" marginheight=\"0px\"><\/iframe>\r\n\r\nSo if we go back to Mary and Ben\u2019s choices for Hupana Running Company:\r\n<ol>\r\n \t<li style=\"font-weight: 400;\">Lower quality raw material that is the budgeted price, but will raise the units needed per pair of shoes<\/li>\r\n \t<li style=\"font-weight: 400;\">Higher quality raw material that costs more than the budgeted price, but will use the budgeted number of units per pair \u00a0on budget.<\/li>\r\n<\/ol>\r\nHow do we choose? We need to look at the overall difference in cost between the two options!\r\n\r\nSo let\u2019s put it into numbers:\r\n<ul>\r\n \t<li>Raw material 1: $2.50 per unit\u00a0\u00d7 5 units per pair = $12.50 per pair<\/li>\r\n \t<li>Raw material 2: $2.00 per unit\u00a0\u00d7 6 units per pair = $12.00 per pair<\/li>\r\n<\/ul>\r\nBoth options are higher than the direct materials budget per pair, but which one is the better option? What other factors may come into play here? Let\u2019s think back to our production time, and how they correlate to direct labor. Might that be an issue as well? What if raw material 2, at its lower cost, ends up adding to the direct labor time per pair?\r\n<div class=\"textbox\">\r\n<h3>Raw Material 1<\/h3>\r\n$2.50 per unit\u00a0\u00d7 5 units per pair = $12.50 per pair\r\n\r\nDirect labor per pair = .45 hr, @ $20 per hour = $9\u00a0per pair so a total of $21.50\u00a0per pair\r\n\r\n<\/div>\r\n<div class=\"textbox\">\r\n<h3>Raw Material 2<\/h3>\r\n$2.00 per unit\u00a0\u00d7 6 units per pair = $12.00 per pair\r\n\r\nDirect labor per pair = .5 hr @ $20 per hour= $10 per pair so a total of $22.00 per pair.\r\n\r\n<\/div>\r\nSo how does that change our decision? We now have to look at the differential cost between the two choices. The best choice now, is raw material 1, right? It has a higher cost per unit, but it saves production time.\r\n\r\nIn this example, which costs are relevant costs? The raw material price and the direct labor cost both make a difference, so both of these costs would be relevant as you looked at your options. What if there was no change in the direct labor needed, regardless of the cost of the raw material? Then the direct labor cost would be come in irrelevant cost. If that was the case, we could disregard that option to save us time in our decision making process.\r\n\r\nNow onto costs we can avoid!\r\n<div class=\"textbox tryit\">\r\n<h3>Practice Questions<\/h3>\r\nhttps:\/\/assess.lumenlearning.com\/practice\/335aa153-d763-4540-adf3-548501ad66cf\r\n<\/div>","rendered":"<div class=\"textbox learning-objectives\">\n<h3>Learning Outcomes<\/h3>\n<ul>\n<li>Define differential cost<\/li>\n<\/ul>\n<\/div>\n<p>Managers have a multitude of decisions to make. Which product to make, how much to sell it for, to make or buy raw materials and components, how and where to distribute the product and so forth. Each of the decisions has at least two options.<\/p>\n<p>When we work to make decisions, we need to look at the pros and cons of each option. The key to making these decisions is called differential analysis-focusing on the pros and cons (costs and benefits) that <strong>differ<\/strong> between the two options.<\/p>\n<p>Differential cost can then be defined as the difference in cost between any two alternative choices.<\/p>\n<p><iframe loading=\"lazy\" src=\"\/\/plugin.3playmedia.com\/show?mf=4309241&amp;p3sdk_version=1.10.1&amp;p=20361&amp;pt=375&amp;video_id=-IhNuUIGce4&amp;video_target=tpm-plugin-2cf7a52l--IhNuUIGce4\" width=\"800px\" height=\"450px\" frameborder=\"0\" marginwidth=\"0px\" marginheight=\"0px\"><\/iframe><\/p>\n<p>So if we go back to Mary and Ben\u2019s choices for Hupana Running Company:<\/p>\n<ol>\n<li style=\"font-weight: 400;\">Lower quality raw material that is the budgeted price, but will raise the units needed per pair of shoes<\/li>\n<li style=\"font-weight: 400;\">Higher quality raw material that costs more than the budgeted price, but will use the budgeted number of units per pair \u00a0on budget.<\/li>\n<\/ol>\n<p>How do we choose? We need to look at the overall difference in cost between the two options!<\/p>\n<p>So let\u2019s put it into numbers:<\/p>\n<ul>\n<li>Raw material 1: $2.50 per unit\u00a0\u00d7 5 units per pair = $12.50 per pair<\/li>\n<li>Raw material 2: $2.00 per unit\u00a0\u00d7 6 units per pair = $12.00 per pair<\/li>\n<\/ul>\n<p>Both options are higher than the direct materials budget per pair, but which one is the better option? What other factors may come into play here? Let\u2019s think back to our production time, and how they correlate to direct labor. Might that be an issue as well? What if raw material 2, at its lower cost, ends up adding to the direct labor time per pair?<\/p>\n<div class=\"textbox\">\n<h3>Raw Material 1<\/h3>\n<p>$2.50 per unit\u00a0\u00d7 5 units per pair = $12.50 per pair<\/p>\n<p>Direct labor per pair = .45 hr, @ $20 per hour = $9\u00a0per pair so a total of $21.50\u00a0per pair<\/p>\n<\/div>\n<div class=\"textbox\">\n<h3>Raw Material 2<\/h3>\n<p>$2.00 per unit\u00a0\u00d7 6 units per pair = $12.00 per pair<\/p>\n<p>Direct labor per pair = .5 hr @ $20 per hour= $10 per pair so a total of $22.00 per pair.<\/p>\n<\/div>\n<p>So how does that change our decision? We now have to look at the differential cost between the two choices. The best choice now, is raw material 1, right? It has a higher cost per unit, but it saves production time.<\/p>\n<p>In this example, which costs are relevant costs? The raw material price and the direct labor cost both make a difference, so both of these costs would be relevant as you looked at your options. What if there was no change in the direct labor needed, regardless of the cost of the raw material? Then the direct labor cost would be come in irrelevant cost. If that was the case, we could disregard that option to save us time in our decision making process.<\/p>\n<p>Now onto costs we can avoid!<\/p>\n<div class=\"textbox tryit\">\n<h3>Practice Questions<\/h3>\n<p>\t<iframe id=\"assessment_practice_335aa153-d763-4540-adf3-548501ad66cf\" class=\"resizable\" src=\"https:\/\/assess.lumenlearning.com\/practice\/335aa153-d763-4540-adf3-548501ad66cf?iframe_resize_id=assessment_practice_id_335aa153-d763-4540-adf3-548501ad66cf\" frameborder=\"0\" style=\"border:none;width:100%;height:100%;min-height:300px;\"><br \/>\n\t<\/iframe>\n<\/div>\n\n\t\t\t <section class=\"citations-section\" role=\"contentinfo\">\n\t\t\t <h3>Candela Citations<\/h3>\n\t\t\t\t\t <div>\n\t\t\t\t\t\t <div id=\"citation-list-565\">\n\t\t\t\t\t\t\t <div class=\"licensing\"><div class=\"license-attribution-dropdown-subheading\">CC licensed content, Original<\/div><ul class=\"citation-list\"><li>Differential Cost. <strong>Authored by<\/strong>: Freedom Learning Group. <strong>Provided by<\/strong>: Lumen Learning. <strong>License<\/strong>: <em><a target=\"_blank\" rel=\"license\" href=\"https:\/\/creativecommons.org\/licenses\/by\/4.0\/\">CC BY: Attribution<\/a><\/em><\/li><\/ul><div class=\"license-attribution-dropdown-subheading\">All rights reserved content<\/div><ul class=\"citation-list\"><li>Part 1 - Relevant Costs for Decision Making - Sunk and Differential Costs. <strong>Authored by<\/strong>: Tony Bell. <strong>Located at<\/strong>: <a target=\"_blank\" href=\"https:\/\/www.youtube.com\/watch?v=-IhNuUIGce4&#038;feature=youtu.be\">https:\/\/www.youtube.com\/watch?v=-IhNuUIGce4&#038;feature=youtu.be<\/a>. <strong>License<\/strong>: <em>All Rights Reserved<\/em><\/li><\/ul><\/div>\n\t\t\t\t\t\t <\/div>\n\t\t\t\t\t <\/div>\n\t\t\t <\/section>","protected":false},"author":62559,"menu_order":3,"template":"","meta":{"_candela_citation":"[{\"type\":\"original\",\"description\":\"Differential Cost\",\"author\":\"Freedom Learning Group\",\"organization\":\"Lumen Learning\",\"url\":\"\",\"project\":\"\",\"license\":\"cc-by\",\"license_terms\":\"\"},{\"type\":\"copyrighted_video\",\"description\":\"Part 1 - Relevant Costs for Decision Making - Sunk and Differential Costs\",\"author\":\"Tony Bell\",\"organization\":\"\",\"url\":\"https:\/\/www.youtube.com\/watch?v=-IhNuUIGce4&feature=youtu.be\",\"project\":\"\",\"license\":\"arr\",\"license_terms\":\"\"}]","CANDELA_OUTCOMES_GUID":"b84d3e86-94a4-4665-be79-c010cf40ec9d, fbe26851-78f2-4a8b-a6ee-d1d336952779","pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"class_list":["post-565","chapter","type-chapter","status-publish","hentry"],"part":110,"_links":{"self":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapters\/565","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/wp\/v2\/users\/62559"}],"version-history":[{"count":10,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapters\/565\/revisions"}],"predecessor-version":[{"id":4136,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapters\/565\/revisions\/4136"}],"part":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/parts\/110"}],"metadata":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapters\/565\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/wp\/v2\/media?parent=565"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapter-type?post=565"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/wp\/v2\/contributor?post=565"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/wp\/v2\/license?post=565"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}