A (Very Brief) Introduction to Incremental Cost Concepts

Part I

Incremental costing methods measure the economic consequences of decision alternatives.  Incremental costs are typically used to answer the generic question: "How will the total costs of the organization change if I make a decision to do X -- as opposed to continuing with the status quo (or some other baseline alternative)?"  The decision in question may involve a major financial impact to the organization, or may involve a relatively small potential impact.

How much more (or less) will it cost for the organization to employ its own sales force as opposed to continuing to employ a network of exclusive resellers?  How much additional cost will be incurred by the organization to provide one more hour of childcare this coming Thursday -- or provide a large corporate customer with childcare for one thousand employees over the next eighteen months?
For this reason, incremental methods are naturally appropriate to provide cost information relevant to making decisions.  This strict focus on identifying relevant information for a decision is a hallmark of incremental analysis -- and distinguishes incremental cost methods from most other cost accounting methods.

By contrast, the cost information used in financial accounting and public financial reporting is based on standard "cookbook" formulas.  Use of such formulas allows an organization to quickly apportion its total costs to different sub-units or activities -- and to declare, for example, that the cost of producing its "WhisperSensitive" line of baby monitors last quarter was $453,281 and an average of $15.25 per unit.  The uniformity of the cookbook (promulgated by bodies such as the Financial Accounting Standards Board) is intended to ensure arms-length objectivity, allow for the comparison of the financial health of different organizations, and offer relative simplicity of application and audit.

Outside of the niceties of financial accounting, however, the conditions rarely exist for an organization to identify a single, definitive cost per unit or total cost of its products or services.  In recognition of this reality, the measure of an incremental cost depends on the particular decision whose cost is being evaluated.

So for each      DECISION      there is a corresponding set of     INCREMENTAL COSTS      . . .