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Krysten P Coughlin

AC330: Managerial Accounting for Business Professionals

April 19, 2012

1) Discuss the three cost concepts used in incremental analysis and explain their importance in incremental analysis.

A) Sunk Costs - Two costs that are often misunderstood or used incorrectly. Sunk costs are, first of all, always-irrelevant costs. They maybe excluded in any analysis or cost comparison review. Sunk costs are historical costs; that is, past expenditures. Because they are expenditures already made the expenditure cannot be changed. To incur or not incur is not an option now. Examples of sunk cost are cost of fixed assets such as buildings or equipment. By the same token, depreciation is also a sunk cost. The book value of a fixed asset (cost – accumulated depreciation) is also a sunk cost.

Sunk costs have two important dimensions—size and timing.6 consider the following scenario:

A family has tickets to a basketball game and has been antici­pating the game for some time. The tickets are worth $40. On the day of the game there is a big snowstorm. Although they can still go to the game, the snowstorm will cause a hassle that reduces the pleasure of watching the game. Is the family more likely to go to the game if they purchased the tickets for $40 or if the tickets were given to them for free?

Mast people think the family is more likely to go to the game if they purchased the tickets. You see, the $40 cost of the tickets does not factor into the hassle of the snowstorm or the pleasure derived from the game. Yet people consider the sunk cost in the decision as to whether to go or not. A family that pays for the tickets opens a men­tal account. If they do not attend the game, they are forced to close the mental account without the benefit of enjoying the game, resulting in a perceived loss. The family wishes to avoid the emo­tional pain of the loss and, therefore, is more likely to go to the...