Introduction
Differential analysis sometimes referred to as marginal or incremental analysis is applied when
analyzing and evaluating financial information that’s needed for major decision making.
Differential analysis identifies the right revenues or costs that each alternative presents and the
impact of each alternative on the future income. The following concepts are widely used in
differential analysis, a) Relevant costs. These are generally revenues and costs that are different
or differ from the given alternatives while the others basically remain unchanged and this are
ignored while the alternatives are being analyzed. Relevant revenues that change are at times
referred to as relevant benefits. b) Sunk costs. These are costs that have been already incurred
and their impacts on the future decisions are minimal i.e. the cost will remain the same. c)
Opportunity cost. These are the potential revenues or benefits that are lost when a firm decides
and chooses another alternative. (Agrawal, 2010)
The list of relevant expenses for Herrestad Company are the Direct materials costs, the variable
and administrative costs are zero for product all the products while the direct materials are zero
for product C while for product B and A are $12000. (Hermanson, Edwards, & Invacevich,
2011)
Accounting 2
Total units required are one thousand units. The cost per unit of product C is $150 and later
adjusted to $140. The direct materials are expected to decrease by $12 per unit i.e. by 8% for the
initial cost of product C at $150 per unit while for the second adjusted price is 8.6%.
In part I, the first alternative has a differential revenue of zero i.e. the revenues from both
alternatives are similar and the net revenue is zero. The differences are encountered on the costs
of the two alternatives. The cost of the product C is $12 per unit less than the original product B.
For one thousand units, the total cost of alternative C will be $12000 less than the original
product B. The differential costs will be $12000 between the two. The marginal cost of product
C is $12000 while for product B is zero. The net differential loss from the alternatives is $12000.
Part I
Herrastad Company
Differential Revenue from
alternatives
Revenue from Alternative C 150000
Revenue from Alternative B 150000
Differential Revenue 0
Differential cost of
alternatives
Cost of Alternative C 0
Cost of
B
12000
Differential cost 12000
Net differential income or loss
from alternatives. -12000
Part II
Herrastad Company
Differential Revenue from
Accounting 3
alternatives
Revenue from Alternative C 150000
Revenue from Alternative A 140000
Differential Revenue 10000
Differential cost of alternatives
Cost of Alternative C 0
Cost of Alternative A 12000
Differential cost 12000
Net differential income or loss
from alternatives. -2000
In part II, the first alternative has a differential revenue of $10000 i.e. the revenues from both
alternatives have a difference of $10000 between them. The differences are encountered on the
costs of the two alternatives. The cost of the product C is $12 per unit less than the cost of
product A. For one thousand units, the total cost of alternative C will be $12000 less than the
product A. The differential costs will be $12000 between the two. The marginal cost of product
C is $12000 while for product A is zero. The net differential loss from the alternatives is $2000.
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Product C has the greatest advantage against the other two alternatives. Product C has no
administrative or variable costs. In part I, The selling price per unit is $150 and the basic cost for
product C is less than the costs of product B by $12000. The differential loss of $12000 i.e. the
expenses are 12000 more for product C than product B. The best alternative is product C, then
product B and finally product A. For product A, the revenues are less than the revenues for
product C by $10000. The costs are more for product A than C by $12000. The net differential
loss is $2000. Product A has less revenue and the costs are the same as product B. This makes it
Accounting 4
the least alternative. As a manager of Herrastand Company, I would accept the order. The order
would make an initial profit of 8% while the adjusted order would make 8.6%.
To conclude, the offer of the order is profitable compared with the initial order of the Company.
The marginal revenue would be Zero while the marginal cost is $12000. While the second part,
the marginal revenue would be negative $10, 000.If the company decides to take the second
order then it would lose $10000. The total revenue would be $140000 compared to $150000 to
be received on the agreed offer. The costs and revenues are the same.
References
Agrawal, N. K. (2010). Principles of Management Accounting, Global Media from Trident
online library.
Hermanson, R.H., Edwards, J.D., & Invacevich, S.D. (2011). Accounting Principles: A Business
Perspective. First Global Text Edition, Volume 2 Managerial Accounting, 108-113, 128-134,
165-169 and 181-183.
