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What are the common examples of differential revenues in variable costing?

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Variable costing is a method of accounting that only assigns variable costs to the production of goods or services. This means that fixed costs, such as rent, depreciation, or salaries, are treated as period expenses and deducted from revenue in the income statement. Variable costing can be useful for making short-term decisions, such as whether to accept a special order, discontinue a product line, or outsource a process. However, it can also lead to some differences in how revenues are calculated and reported. In this article, you will learn what differential revenues are and how they are affected by variable costing.

本文章的要点总结

Analyze market factors:

Understand the impact of changes in sales volumes, pricing, and product mixes to make informed decisions. Knowing these variables can help you predict differential revenues and adjust strategies accordingly.
Consider long-term effects:

While differential revenues aid short-term choices, for longevity, factor in market demand and sustainability. This holistic view ensures your financial strategy supports future growth as well as present gains.

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Asha Kanta Sharma

Manager - Finance & Accounts @…
cma Madan Mohan Bhattacharyya

Qualified Member of Chartered Public…

1 What are differential revenues?

Differential revenues are the changes in total revenues that result from choosing one alternative over another in a decision-making situation. For example, if you have a limited capacity and you can either produce and sell product A or product B, the differential revenue is the difference between the revenues from selling product A and the revenues from selling product B. Differential revenues can also be called incremental revenues or relevant revenues, as they reflect the additional or relevant revenues that are influenced by the decision.

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Asha Kanta Sharma

Manager - Finance & Accounts @ Opendoors Fintech | Financial Accounting
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Variable costing refers to changes in revenues resulting from different levels of production or sales volume. Examples include sales volume changes, price changes, product mix changes, discounts and promotions, geographic expansion, market share changes, seasonal fluctuations, introduction of new products or services, discontinuation of products or services, changes in distribution channels, contract negotiations, economic conditions, competitor actions, and customer preferences. Analyzing these factors helps businesses make informed decisions about pricing, product mix, marketing strategies, and overall business planning.

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2 How to calculate differential revenues?

To calculate differential revenues, you need to compare the revenues from each alternative and subtract the smaller amount from the larger amount. For example, if product A generates $10,000 in revenues and product B generates $8,000 in revenues, the differential revenue is $10,000 - $8,000 = $2,000. This means that by choosing product A over product B, you will increase your revenues by $2,000. However, you also need to consider the costs and profits associated with each alternative, as they may affect your decision.

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3 How does variable costing affect differential revenues?

Variable costing affects differential revenues by changing the way fixed costs are allocated and reported. Under variable costing, fixed costs are not assigned to the products, but rather expensed in the income statement. This means that the unit cost of each product only includes the variable costs, such as direct materials, direct labor, and variable overhead. Therefore, the differential revenue is the same as the differential contribution margin, which is the difference between the contribution margins of each alternative. The contribution margin is the difference between the revenue and the variable cost of a product.

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4 What are the advantages of using differential revenues in variable costing?

Using differential revenues in variable costing can have some advantages for decision-making purposes, such as simplifying the calculation of the differential costs and profits, as you only need to compare the variable costs and revenues of each alternative. Ignoring the sunk costs and allocated fixed costs is advantageous in short-term decisions, as they are not affected by the choice of alternatives. Additionally, focusing on the marginal or incremental effects of the decision is more accurate than considering the total or average effects.

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cma Madan Mohan Bhattacharyya

Qualified Member of Chartered Public Finance and Accountants(UK)
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In the perspective of short term decision making, differential revenues in variable costing may be useful. But in terms of long term perspective, we will have to consider so many things, like future changing scenario, market demand, techno economic viability, uncertain parameters, long term sustainability etc.

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5 What are the limitations of using differential revenues in variable costing?

Using differential revenues in variable costing can also have some limitations when making decisions. For instance, it may not reflect the long-term implications of the decision by not taking into account the impact of fixed costs on the profitability and capacity of the business. Furthermore, it may not be consistent with external reporting standards, such as GAAP or IFRS, which require the use of absorption costing for inventory valuation and income measurement. Additionally, it may not account for opportunity costs or qualitative factors that could affect the decision, such as customer satisfaction, market share, or competitive advantage.

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6 What are the common examples of differential revenues in variable costing?

Differential revenues in variable costing can be seen in special orders, make or buy decisions, and product mix decisions. Special orders involve the difference between the revenues from accepting and rejecting the order, which depends on the variable costs and opportunity costs of using available capacity. Make or buy decisions involve the difference between the revenues from making and buying a product or component, which depends on the variable costs and quality/reliability of the supplier. Product mix decisions involve the difference between the revenues from producing and selling one product or product line over another, which depends on the variable costs and contribution margin ratios. All of these examples will help inform stakeholders and provide valuable insights for improving a company's financial posture.

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7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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Siavash Eftekhari

Financial & Economic advisor to Board of Directors at CinnaGen Co.
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Sales discounts: These are reductions in the selling price of a product that are offered to customers who pay their invoices early. Sales returns and allowances: These are reductions in revenue that are given to customers who return products or are not satisfied with their purchases. Quantity discounts: These are reductions in the selling price of a product that are offered to customers who purchase larger quantities of the product. Freight discounts: These are reductions in the cost of shipping a product that are offered to customers who pick up the product themselves or who ship the product using their own carrier.

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What are the common examples of differential revenues in variable costing?

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1 What are differential revenues?

2 How to calculate differential revenues?

3 How does variable costing affect differential revenues?

4 What are the advantages of using differential revenues in variable costing?

5 What are the limitations of using differential revenues in variable costing?

6 What are the common examples of differential revenues in variable costing?

7 Here’s what else to consider

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