Could someone give me a good detailed paragraph for this Managerial Accounting Question?

Question

Please discuss the situations under which incremental analysis is beneficial and how it may be used in each situation.

Answer 1

Incremental analysis works under the following scenarios:

For example in a make or buy situation, the company must decide whether the incremental revenue - incremental costs to make is higher or lower than that to buy, A higher value means it is more beneficial to make if the to make situation result is higher. However, if the company chooses to make the product, than the labour must be retained (higher salaries every month), the machines cannot be sold( to make a fast buck, provided someone is actually waiting to buy), the place cannot be leased to others (same as selling the machines). So if the company decides to buy and lease off the machines, what if tomorrow a good deal comes in (special order) that makes the decision look bad? You got to find someone else to do it for you, and you must question the quality of the product and lead time for delivery. What if the supplier could not fulfil those obligations? If course you can sue. But the customer sues you too. If the case goes to the papers, everyone knows about this, your business cannot survive.

Another example will be the special order situation, the company must decide whether to accept an order or not, take this case: The customer comes into your office and request an order for 100 units of products at $5 each. You retail the goods at $8 each, the cost to produce each is expected to be $3 each. Since you still make money from the deal, you accept, but the problems are, you don't know how the customer will deal with those products, are they going to sell at a cheaper price then what you sell? Also important issue is that if the customer is a fussy one, a slightest quality issue may lead to delayed payments or complains that make it more expensive than the $2 each earned from the deal.

Another issue is with capacity and technology. The company must decide whether to accept or reject a deal or what product to produce with the profit that the business can potentially earn from such a production. If the technology arises, should you buy new machines to produce? You should look at the customers, where are they? Will they buy? Who are your competitors? Will they do the same?

Answer 2

Incremental analysis is used to find the impact of changes in costs or revenues, given a specific potential scenario. Decisions involving incremental analysis include the following:

Make or buy: Should we make a component ourselves or farm out the work to someone else? Qualitative considerations may or may not override quantitative issues. For example, we may be able to subcontract work more economically than we can do it ourselves, but if the contractor is unable to maintain the necessary level of quality or meet delivery schedules, subcontracting may not be worthwhile. The impact of quality and/or delivery problems may not be quantifiable, thus making the whole business a judgment call.

Sell or process further: Sell or process further issues often arise in industries which refine raw materials. The key question is whether the incremental revenues from a more highly refined product will at least offset the increased costs associated with additional processing.

Special order: Special orders typically involve special requests from customers who want a reduced price or some sort of special work. The extra effort might take the form of extra machining, special finishes, rush delivery [which could entail both an accelerated production schedule as well as air freight or other transportation costs], or an unusually small production run. As with the other decisions discussed here, quantitative and qualitative issues may be in conflict. Suppose an especially valuable customer want some sort of special deal, whether a reduced price or extra work. The lower revenue or added costs may mean taking a loss on the job, but we have to decide whether alienating the customer is more serious than the short term hit on profits. Some costs associated with special orders are not easily accounted for. Special production runs may require extra set ups of machinery which increase total indirect costs; however, such costs are often not easily accounted for, and therefore may not be readily added to the charges to the customer, even if the customer is willing to absorb such charges.

Changes in production and/or technology: Modifications in production processes or acquisition of new machinery typically entail adjustments in costs. New machinery or a revised process may enhance efficiency in the use of labor and/or material. It is clearly important to know whether the improvements offset whatever incremental costs may be associated with the changes.