Definition: A difference in costs between any two alternatives.
Also called: incremental cost, relevant cost, avoidable cost
The Core Principle
Only differences matter. Costs identical across all alternatives are irrelevant to the decision.
| Cost Type | Include in Analysis? |
|---|---|
| Differs between alternatives | Yes—differential |
| Same across all alternatives | No—not differential |
Differential Revenue
Same concept applied to income side:
Example
Alternative A: Revenue 85,000 Alternative B: Revenue 60,000
Differential Revenue: 80,000 = 85,000 − 25,000 Differential Operating Income: 25,000 = −$5,000
Decision: Alternative B is better by $5,000
Connection to Economics
| Economics Term | Accounting Term |
|---|---|
| Marginal cost | Differential cost (at one-unit level) |
| Ceteris paribus | ”Hold constant what doesn’t change” |
Differential analysis is the accounting application of marginal thinking.
Identifying Differential Costs
Ask: “If I choose Alternative A instead of B, does this cost change?”
| If Yes | If No |
|---|---|
| Differential—include | Not differential—ignore |
North: Where this comes from
- Costs for Decision Making (parent framework)
- Marginal Analysis (economics foundation)
East: What opposes this?
- Sunk Cost (never differential)
- Committed Cost (locked in regardless of decision)
South: Where this leads
- Make or Buy Decisions (compare alternatives)
- Special Order Decisions (accept at lower price?)
- Keep or Drop Decisions (segment profitability)
- Sell or Process Further (additional processing worth it?)
West: What’s similar?
- Production Possibilities Frontier (tradeoffs between alternatives)
- Incremental Analysis (same concept, different name)
- Avoidable Cost (cost that disappears if activity stops)