I understand the concept, or at least I thought I did. The question is.

2. All of the costs listed above, except one, are differential costs between the alternatives of Todd producing brooms or staying with the janitorial service. Which cost is not differential? Explain.
Janitorial Job $2000 (this represents the opportunity cost of deciding to leave his current career to go and make brooms.)
Rent (production) - $1500 (how much the broom factory will cost in rent per month)
Production Equipt Rental. - $550 (per month)
Cost of materials - $11.50/ per broom (raw material)
Wages - $4.25 per broom (direct cost)
Sales office rent - $250 (administrative cost)
Added voicemail - *$5 (No idea)
Savings interest - $1100/year (He has money in savings that yields 1100 each year. He is taking it out to start up the business, represents the opportunity cost)
Advertising Costs - $450/month (periodic cost)
Sales Commission - $.80 / broom (periodic cost)
Legal and Filing Fee's - $1,500 (periodic cost)


I have no idea which cost is not differential. Any help would be awesome.


*Voicemail was added to take calls to help customers afterhours

This post was edited by m3d1c on Sep 22 2017 12:16pm

Who's sales commission is it? The commission he pays to a saleman or the commission he gets per broom? If it's the latter, I believe that would be what isn't a differential cost - as that is a revenue.

Did you reword and reorganize the question or is this copy/pasted? This is a mess.

Terrible teacher if this is the actual question.

I assume the author means relevant costs?

If you had provided the full question it would be easy to answer. The question you have posted doesn't specify whether the advertising/sales office rent etc. are relating to the proposed expansion of operations or if they were already being incurred.

The problem with accounting is that these ideas and definitions are often very vague. And many accountants are very strict about THEIR definitions, despite the fact that the term, idea, or definition requires additional context.

(1) An opportunity cost refers to two decisions (A) or (B), and what potential benefit(s) were given up as a result of choosing (A) over (B). Asking "what's the opportunity cost" is a very vague thing though. For example, if opportunity (A) renders $5,000 in cash per month, and opportunity (B) renders $2,000 cash per month, and there are absolutely no other details, then there is no opportunity cost; the idea of opportunity cost is that option (B) is different in some potentially beneficial way. Given the same scenario, if option (A) offered income from a client who pays infrequently (between 0 and 180 days from invoice), and option (B) was for a client who pays within 5 days, then the opportunity cost of taking option (A) would be you're giving up receiving regular, predictable payments. As soon as more factors are thrown into the mix, the answer of what comprises opportunity cost really depends on what the business values.

(2) A differential cost, as I understand it, is simply the difference in cost between two options (not to be confused with differential revenues, or differential net income). The idea here is that you compare apples to apples, in what is typically a horizontal comparison. Cost of goods sold to cost of goods sold, advertising to advertising, etc. The problem with asking what differential cost is without giving context, is that it can mean total differential cost of an entire company... or specific differential cost between specific things (ie. just advertising). As far as I understand it, differential cost isn't supposed to be a comparison of choosing between purchasing a used truck or an expensive photocopier. It's about comparing costs that could potentially comprise financial statement line items. So, while the choice between the truck or the photocopier could comprise one part of the differential cost comparison, that in itself isn't the essence of applying a differential cost analysis.

Anyways, for this case, here is your answer:

- The opportunity cost is not a differential cost, because it represents revenues given up, not costs given up. Although if it were a cost, it'd still be murky, because it's non-recurring, and as such the differential cost would have an asterisk to say it's a fixed one-time portion of the total differential cost for period X, not a continuing differential cost.

This post was edited by Canadian_Man on Sep 27 2017 08:52pm

You're thinking too deep. Opportunity cost is literally "I want to quit my job to start my own consulting business. In my current occupation I make $65,000. The opportunity cost of leaving my job is $65,000."

Opportunity cost in accounting and finance is pure cost analysis. It has nothing to do with benefits and intangibles.

Differential costs are equally on the same level of comparison. In this question, they are asking which factor would not be considered in an analysis of differential costs compared with his current job. In his current job he doesn't need to rent an office building, so the differential cost is the amount you would pay for the office building minus 0. If he were comparing renting an open space warehouse that costed $2200 per month and an automation-integrated factory that costs $5500 per month, the differential cost between these two items would be $3300.

The question is asking, which item is not a differential cost compared with his current janitorial job.
Rent (production) - $1500 (how much the broom factory will cost in rent per month) <-----> Janitorial job, no rent = ($1500)
Production Equipt Rental. - $550 (per month) <-----> janitorial job, no equipment rental = ($550)
Etc, etc.

The first part is correct. The opportunity cost is purely the next best option, or what is being considered the next best option. You are correct, I was wrong.

The second part, I'm not sure why it sounds like you're disagreeing with me. The point of a spot comparison of differential costs is to compare apples to apples, as I said and you said (rent to rent). Differential cost analysis can be widened in scope, to analyze the difference in a large number of costs (all of option A vs. all of option B).

Still leaves my answer at the end correct: Essentially anything that is a relevant cost would be included in a differential cost equation. It is the opportunity cost (the revenue given up), which is not included in the differential cost equation, because it would be part of a differential revenue comparison.

I hate these convoluted terms used in accounting though, especially when they're used, and context is removed as if the term speaks for itself in utter and complete clarity.

I'm not totally disagreeing with you, I just think you're looking at the question on a full scale analysis view when the question is asking simply which costs would be compared as differential costs. You're right in that if we were doing a full analysis this would not be enough information, but I think for the purposes of this question it is - if only it wasn't as sloppy.

I think you misread the question. I’m wondering why this is even an issue this is 1+1=2 in terms of what the answer is. The question says there are two options:

(1) Make brooms
(2) Stick with original business

It lists a bunch of info and says which is not a differential cost between the two options. The answer is quick and simple: it’s the opportunity cost, because that’s revenue given up, not a cost. All of the costs would be differential costs in a comparison, because when you compare differential costs between two choices, you factor ALL costs (except costs that are the same between the two options, though that would go in and just 0 out).

This post was edited by Canadian_Man on Sep 28 2017 02:52pm

Then how do you explain interest lost? That's a revenue given up.