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Incremental Analysis

286 words - 2 pages

Assume that AT, Inc. plans to produce and sell 80,000 calculators next year to be sold at \$7 each. Management is considering raising the selling price to \$8 per unit, but this is likely to cause the sales volume to drop to 76,000 units. Since both units and selling price will change, you must consider both changes as part of the incremental revenue. The incremental approach determines the difference ...view middle of the document...

and fixed costs are \$100,000. The relevant variable cost is the difference between the total variable costs in both alternatives. There will be a cost savings for variable costs because fewer units will be sold. Because fixed costs remain the same at all levels of activity, there is no change to fixed costs.
The relevant variable cost is \$4 per unit. The number of units will decrease given that 4,000 fewer units (80,000 - 76,000) will be sold. Instead of additional costs, there will be a cost savings:

Variable cost savings: (80,000 - 76,000) x \$4 \$16,000

Therefore
Original revenue: 80,000 x \$7 \$560,000
Adjusted revenue: 76,000 x \$8 608,000
Incremental revenue +\$48,000
Variable cost savings:
(80,000 - 76,000) x \$4 + 16,000
Incremental increase in profit +\$64,000

The net effect of the changes is an increase in profit of \$64,000. As we can see here, the incremental analysis did not determine the total profit under either alternative. Only the relevant amounts were considered.

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