Page 858 - Accounting Principles (A Business Perspective)

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22. Short-term decision

making: Differential analysis

Learning objectives
After studying this chapter, you should be able to:
• Compare and contrast contribution margin income statements to traditional income statements.
• Explain differential analysis and describe its components.
• Make pricing decisions using differential analysis.
• Use differential analysis to decide whether to accept or reject special orders.

• Decide whether to eliminate or add product lines or segments of the business using differential analysis.
• Use differential analysis to decide whether to sell joint products at the split-off point or process them further.
• Decide whether to make or buy products using differential analysis.
• Use differential analysis to decide whether to improve product quality.
In this chapter, we will discuss how companies use financial information in making decisions. The framework
for our discussion is differential analysis. We begin by presenting an alternative to the traditional income statement
format. This alternative, the contribution margin income statement, generally is more useful for the managerial

decisions we discuss in this chapter. Then we discuss differential analysis as a method of choosing the best solution
to decision problems. We also present several applications of differential analysis to managerial problems that you
will likely encounter.
Contribution margin income statements

Both this and the previous chapter discuss the use of accounting for managerial decision making. We have
introduced the concepts of fixed and variable costs, and shown how you can use these concepts in making decisions.
However, income statements published for external use do not break costs down into fixed and variable
components. We now present another income statement that not only breaks down costs into their fixed and
variable components but also presents the total contribution margin. The contribution margin income statement
subtracts variable costs from revenues to show the contribution margin, and then subtracts fixed costs to derive net

income.
You can see the differences between the traditional and contribution margin income statements by contrasting
two income statements based on the same data. Assume Bart Company had the following data relating to
manufacturing and sales activities for May 2011:
Bart Company
May 2011
Variable manufacturing costs (per unit):
Direct materials $ 1
Direct labor 1
Overhead 1
Total 3
Variable selling expenses (per unit) $0.50
Fixed costs:

Accounting Principles: A Business Perspective 859 A Global Text