Relevant Cost
Relevant cost is a managerial accounting term that describes avoidable costs that are incurred only when making specific business decisions. The concept of relevant cost is used to eliminate unnecessary data that could complicate the decision-making process. As an example, relevant cost is used to determine whether to sell or keep a business unit.The opposite of a relevant cost is a sunk cost, which has already been incurred regardless of the outcome of the current decision.
Definition: Relevant cost is a term in managerial accounting that describes avoidable costs that arise only when making specific business decisions. These costs are crucial in the decision-making process as they directly impact the final choice.
Origin: The concept of relevant cost originated in managerial accounting to help businesses eliminate unnecessary data interference during decision-making. As business management theories evolved, relevant cost became an important analytical tool for optimizing resource allocation and improving decision efficiency.
Categories and Characteristics: Relevant costs are mainly divided into two categories: incremental costs and opportunity costs. Incremental costs refer to additional costs incurred due to a specific decision, such as the cost of adding a new production line. Opportunity costs refer to the potential benefits lost when choosing one option over another. The characteristics of relevant costs are that they are avoidable, variable, and directly related to specific decisions.
Specific Cases: Case 1: A manufacturing company is considering whether to add a new production line. Relevant costs include the purchase cost of new equipment, additional labor costs, and raw material costs. Case 2: A retail company is considering whether to close an underperforming store. Relevant costs include severance pay, inventory handling costs, and lease contract penalties.
Common Questions: Common questions investors have when applying the concept of relevant cost include how to accurately identify the difference between relevant costs and sunk costs, and how to eliminate irrelevant data interference in complex decision-making environments. A common misconception is mistaking sunk costs for relevant costs, which can affect the accuracy of decisions.
