Question

Managerial Accounting 16th Edition - Chapter 12: Differential Analysis - Relevant Costs

Airlines sometimes offer reduced rates during certain times of the week to travelers. How does the concept of relevant costs and differential analysis enter into this decision by the airline to offer reduced rates of this type?

Answer 1

Airlines offer discount during certain times to increase the contribution margin. Contribution margin is the difference between sales and variable cost. The incremental contribution margin helps in recovery of fixed cost by improving capacity utilisation. The relevant cost for analysis is variable cost only. The differential analysis will include the following

· Increase in sales revenue due to additional ticket sales

· Increase in variable cost for the additional ticket sales- passenger meals, baggage handling charges, commission for ticket sales, etc.

· The incremental contribution (Incremental revenue- Incremental cost) helps in recovery of fixed cost and reduces the operating losses or increases the operating profit.

Fixed cost is irrelevant cost and not included in decision making for differential analysis.