Question

Granite Construction Company is considering selling excess machinery with a book value of $175,000 (original cost of $315,000 less accumulated depreciation of $140,000) for $180,000, less a 5% brokerage commission. Alternatively, the machinery can be leased for a total of $200,000 for four years, after which it is expected to have no residual value. During the period of the lease, Granite Construction Company's costs of repairs, insurance, and property tax expenses are expected to be $34,400.

Senior Construction Management is asking the accounting team to prepare and present, during a meeting, a differential analysis, dated November 7 to determine whether Granite should lease (Alternative 1) or sell (Alternative 2) the machinery.

Differential Analysis
Lease Machinery (Alt. 1) or Sell Machinery (Alt. 2)
November 7
	Lease Machinery (Alternative 1)	Sell Machinery (Alternative 2)	Differential Effect on Income (Alternative 2)
Revenues	$200,000	$180,000	$20,000
Costs	-34,400	-9,000	25,400
Income (Loss)	$165,000	$171,000	$5,400

1. Define differential analysis and discuss its importance in management decision making.
2. On the basis of the data presented, would it be advisable to lease or sell the machinery?
3. How will you advise the senior level managers, in the meeting?

Answer 1

Differential Analysis: This management accounting technique is also known as incremental analysis. This analysis involves analysis of different cost and benefits from accepting one alternative over the other. Differential revenue is the difference between two alternatives available and differential cost or expenses is the difference between the amounts of relevant cost of different alternatives available. Further the cost is same in different alternatives, sunk cost or past cost then these cost are irrelevant for decision making.

The net inflow from sell of machinery is higher than lease. So to sell the machinery is advisable.

As shown in differential analysis the differential Revenue From lease and sale will be $ 20000 higher but the differential cost will be $ 25400 higher. So as per differential analysis if the machinery will be sold then it is more profitable. In case of Sale of machinery the company’s net inflow will increase by $ 5400.