Differential analysis

Definition

Differential analysis is the process of comparing the financial differences between decision alternatives. It focuses on identifying relevant costs and revenues that change under different courses of action.

5 Must Know Facts For Your Next Test

1. Differential analysis only considers relevant costs and revenues that differ between alternatives.
2. Sunk costs are ignored in differential analysis because they do not affect future decisions.
3. Opportunity cost is a key consideration in differential analysis as it represents the potential benefit lost when one alternative is chosen over another.
4. Fixed costs may be included in differential analysis if they change as a result of the decision.
5. The primary goal of differential analysis is to aid in short-term decision-making by highlighting financial impacts.

Review Questions

• What types of costs are ignored in differential analysis?
• Why is opportunity cost important in differential analysis?
• How does differential analysis assist in short-term decision-making?

Related terms

Relevant Costs: Costs that will be affected by a decision and should be considered during differential analysis.

Opportunity Cost: The benefit foregone by choosing one alternative over another.

Sunk Costs: Past costs that have already been incurred and cannot be recovered; these are irrelevant to future decisions.