Chapter 21
Incremental Analysis

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Incremental Analysis can be used for more than just complex business decisions. Here’s a good example of a personal decision that can be evaluated using a differential accounting approach.
 

Dorothy’s Car
Dorothy is an elderly woman living in an urban area with adequate public transportation to meet her needs. She has a car, and also some concerns. She is trying to decide whether to keep the car, or sell the car and use public transportation. If she keeps the car she will have the following annual expenses:
 

gasoline	$ 500
insurance	$ 480
maintenance	$ 360

She also takes a trip out of town every year to visit her sister. Her travel costs are:
 

gasoline	$ 125
lodging	$ 200

Dorothy is worried that she might have an accident with her car. Her insurance costs have been going up as her age increases. Also, the cost of maintenance will increase as the car gets older. 

She estimates she would spend $1000 per year on public transportation for her regular activities. Airfare to visit her sister would cost $350. 

REQUIRED:

Using Incremental Analysis, compare Dorothy’s two options. Based on this analysis alone, which would be the better option? What other considerations might effect Dorothy’s decision?

After you give the problem a try, you can check the solution for Dorothy's Car

Here's another example of Incremental Analysis, based on some common business choices.

A Stitch In Time

Easton Company is a custom stitchery specializing in the manufacture of men’s and women’s underwear. They manufacture for a variety of customers under several brand labels. 

The stitchers are paid $4.80 per dozen of finished garments. At the end of the day each stitcher’s total production is calculated and valued. Full Dozens are calculated using a weighting method. The garments are inspected and graded as follows: Pass, Seconds, Scrap. Stitchers are paid full price for Pass, half price for Seconds and nothing for Scrap. In other words, two dozen Seconds will be paid equivalent to one dozen Pass. 

The company has a waiting list of candidates for work. They want to establish some criteria for performance and be able to maximize their profits. They also want to reward excellent workers with a bonus, and replace poor workers who are not able to meet a minimum quota, or who consistently have too many Seconds and Scrap.

The company charges customers $6.35 per dozen for stitching, in addition to other charges for materials, cutting, inspection packaging, etc. The stitchery section has overhead of $12,000 per month and there are 30 workstations.  They work 22 days per month, on average. 

They are considering the following bonus incentive plan:
 

dozen per day	bonus per dozen
20	10 cents
24	20 cents

For output below these amounts there would be no bonus, just regular pay. . 

They also want to determine the lowest amount of production that should be acceptable. In management’s opinion an average or above average worker is better than a poor worker, and the company would benefit by eliminating those who are not meeting some minimum level of output.

Workers produce between 8 dozen and 24 dozen per 8 hour shift. Average workers produce 14 to 18 dozen per shift.  Most of the workers are Average, a few are Excellent and a few are Poor (low production and/or too many Seconds and Scrap). 
 

REQUIRED
Evaluate management’s options. Evaluate the company’s cost structure in the stitching department. Hint: determine the total cost per dozen at different production levels.  .

Evaluate the bonus suggestion. Although a bonus will cost the company more, will they receive a sufficient benefit to offset the additional cost? Will a bonus encourage Average workers to produce at higher levels? Will this be good for the company? 

What minimum production level is acceptable? We will assume that a worker not able to meet his level will be replaced. Is this a valid management concern and is replacing workers the correct solution?

Quantify your answers.

After you give the problem a try, you can check the solution for A Stitch in Time

Shave and a haircut

Max owns a salon. He has 6 barber chairs and workstations. His total overhead is $7,000 per month, which includes mortgage interest, utilities, depreciation, supplies, etc. Max allocates his overhead to the 6 barber chairs. 

Max has several barbers working for him full time. Barbers work 8 hours per day, 6 days per week; they work an average of 26 days per month. Max pays his barbers $12.50 per hour (including payroll taxes, etc.), and they average three haircuts per hour. (Yes, they also make tips.)

Max would like to improve his income. His business appears profitable, but he is paying off a mortgage on the building, and has other business expenses to think of as well. As far as he’s concerned an empty chair is lost revenue. He is considering several options, including hiring stylists and/or renting chairs by the day to other barbers and stylists who would work their own hours and bring in their own customers.

If he hires stylists his payroll costs would be $15.50 per hour. He estimates a stylist will serve 1 customer per hour, and the average income will be $30 per customer. 

He is also considering leasing chairs by the day to barbers or stylists who would provide their own clients, and charge any amounts they want. Max will make only the lease amount, which will be paid by the stylist or barber directly to Max. 
 

REQUIRED

Help Max analyze this decision. 

What are his average costs and profit per chair per day for barbers? 

What will his average costs and profit be per chair/per day if he hires stylists? 

He is considering renting chairs for an amount roughly equal to the profit per day from barbers. Is this a good idea? Or should he hire stylists instead?

Max makes nothing for an empty chair, and must pay the average daily overhead on that chair. Considering this, what is the minimum amount Max could rent a chair for to just cover his overhead costs?

Do you have any other suggestions for Max?

After you give the problem a try, you can check the solution for Shave and a Haircut