A manufacturing concern sells one of its products under the brand name ‘utility’ at Rs. 3.50 each, the cost of which is Rs. 3.00 each. After further processing, which entails additional material and labour costs of Rs. 2,50 and Rs. 2.00 per number respectively, ‘utility’ is converted into another product ‘Ace’ which is sold at Rs. 8.00 each. (iii) The selling price recommended for the company is Rs. 16/- per unit at an activity level of 1,50,000 units. Determination of the most profitable level of production and price.
The components required by the main factory are to be increased by 20 per cent. The components factory can increase production upto 25 per cent without any additional labour force. Overheads are variable to the extent of 25 per cent of the present amount. The alternative which shows the highest difference between the incremental revenue and the differential cost is the one considered to be the best choice.
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The data used for differential cost analysis are cost, revenue and investments involved in the decision-making problem. According to the Institute of Cost and Management Accountant, London, differential cost may be defined as “the increase or decrease in total cost or the change in specific elements of cost that result from any variation in operations”. (i) To process the entire quantity of ‘utility’ so as to convert it into 600 numbers of ‘Ace’. This will need an additional 500 labour hours.
- Suggest which will be better.
- Labour is paid @ Rs. 2 per unit, the fixed D.
- The differential cost and/or the incremental cost of operating its equipment for the additional 10,000 machine hours was $200,000.
It is advisable to accept the second proposal provided facilities exist for the production of additional numbers of ‘utility’ and to convert them into ‘Ace’. The first proposal results into a loss and hence is not acceptable. The variable cost of manufacture between these levels is 15 paise per unit and fixed cost Rs. 40,000. Acceptance of an offer at a lower selling price.
Differential Cost: Meaning, Features and Applications
Suggest which will be better.
What is the difference between a differential cost and an incremental cost?
(i) Prepare a schedule showing the total differential costs and increments in revenue. Assume a company determined that the annual cost of operating its equipment at 80,000 machine hours was $4,000,000 while the annual cost of operating its equipment at 70,000 machine hours was $3,800,000. Differential cost analysis determines the choice for future course of action and hence it deals with the future costs but even then historical or standard costs, adjusted to the future requirements may be used in differential costing. The total cost figures are considered for differential costing and not the cost per unit. Labour is paid @ Rs. 2 per unit, the fixed D. And other allowances monthly.
(ii) It is profitable for the company to increase the level of production so long as the incremental revenue is more than the differential costs. It is not advisable to increase the level of production to such a level where the differential costs are more than the incremental revenue. In the given problem, the company should set the level of production at 1,50,000 units because after this level differential costs exceed the incremental revenue. The differential cost and/or the incremental cost of operating its equipment for the additional 10,000 machine hours was $200,000. The incremental revenue of Rs. 10,000 is much more than the differential cost of Rs. 3,000, it will increase the profit by Rs. 7,000. Differential cost may be referred to as either incremental cost or decremental cost.
Definition of Differential Cost and Incremental Cost
(ii) To continue the present level of output of ‘utility’ but double the production of ‘Ace’. You are required to work out the incremental profit/loss involved in each of the two proposals and to offer your suggestions. The concern at present produces per day 600 numbers of each of the two products for which 2,500 labour hours are utilised. A company has a capacity of producing 1,00,000 units of a certain product in a month. Differential cost is the change in cost that results from adoption of an alternative course of action. It can be determined simply by subtracting cost of one alternative from cost of another alternative or from the cost at one level of activity, the cost at another level of activity.
When there is an increase in the cost due to increase in the level of production, it is called incremental cost, and when there is decrease in the cost due to decrease in the level of production, it is called decremental cost. A capital commitment definition few definitions of differential cost are given below. Differential costs are the increase or decrease in total costs that result from producing additional or fewer units or from the adoption of an alternative course of action.
Differential costing involves the study of difference in costs between two alternatives and hence it is the study of these differences, and not the absolute items of cost, which is important. Moreover, elements of cost which remain the same or identical for the alternatives are not taken into consideration. Differential costs do not find a place in the accounting records. These can be determined from the analysis of routine accounting records. Discontinuing a product to avoid the losses and increase profits – decision to drop a product line. The additional requirement may be purchased from the market at Rs. 8.50 per unit.