Table of Contents

What Is Relevant Cost in Accounting, and Why Does It Matter?

Updated August 22, 2024

Definition

Relevant cost is a term used by management to refer to costs that are avoidable and are only incurred in connection with specific business decisions.

What Is Relevant Cost?

Relevant cost is a managerial accounting term that describes avoidable c☂osts 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 澳洲幸运5官方开奖结果体彩网:sunk cost, which has already been incurred regardless of thಌe outcome of th𝓀e current decision.

Key Takeaways

Relevant costs are the costs that will be affected by the specific management decision being considered.
The opposite of a relevant cost is a sunk cost.
Management uses relevant costs in decision-making, such as whether to close a business unit, whether to make or buy parts or labor, and whether to accept a customer's last-minute or special orders.

Understanding Relevant Cost

Relevant costs are costs related to a decision. These🅠 costs are not static, will vary depending on which path is taken, and can be avoided.

The decision could result in higher expenses or lower expenses as well as higher or lower revenue. Generally, the cost can be deemed worthwhile if it pays off and results in a high🌳er overall profit.

Relevant costs cꦚan be thought of as future expenses that are incurred only if an opportunity is pursued. They are studied by🗹 companies to determine if one decision is more cost-effective than another.

Important

Relevant costs are future potential expenses, whereas sunk costs are existing expenses that have alrea💦dy been made.

Example of Relevant Cost

Assume a passenger rushes up to the ticket counter to purchase a ticket for a flight that is leaving in 25 minutes. The airline needs to consider the relevant costs to make a decision about the ticket price. Almost all of the costs related to adding the extra passenger have already been incurred, including the plane fuel, airport gate fee, and the salary and benefits for the entire plane’s crew. Because these costs have already been incurred, they are "sunk costs" or irrelevant costs.

The only additional cost is the labor to load the passenger’s luggage and any food that is served mid-flight, so the airline bases the last-minute ticket pricing decision on♎ just a few small costs.

Types of Relevant Cost Decisions

Continue Operating vs. Closing Business Units

A big decision for a manager is whether to close a busine✃ss unit or continue to operate it, and relevant costs are the basis for the decision.

Assume, for example, a chain of retail sporting goods stores is considering closing a group 📖of 𒉰stores catering to the outdoor sports market. The relevant costs are the costs that can be eliminated due to the closure as well as the revenue lost when the stores are closed. If the costs to be eliminated are greater than the revenue lost, the outdoor stores should be closed.

Make vs. Buy

澳洲幸运5官方开奖结果体彩网:Make vs. buy decisions are often an issue for a company that requires component parts to create🍒 a finished product.

For example, a furniture manufacturer is considering an outside vendor to assemble and stain wood cabinets, which would then be finished in-house by adding handles and other details. The relevant costs in this decision are the 澳洲幸运5官方开奖结果体彩网:variable costs incurred by the manufacturer to make the wood cabinets and the price paid to the outside vendor. If the vendor can prಞovide the component part at a lower cost, the furniture manufacturer outsources the work.

Factoring in a Special Order

A special order occurs when a customer places an order near the end of the month, and prior sales have already covered the 澳洲幸运5官方开奖结果体彩网:fixed cost of production for the month.

If a client wants a price quote for a special order, management only considers the variable costs to produce the goods, specifically material and 澳洲幸运5官方开奖结果体彩网:labor costs. Fixed costs, such as a f🔜actory lease or manager salaries, are irrelevant because the firmꦜ has already paid for those costs with prior sales.

If the business decides not to produce the order, the costs associated with its production are considered 澳洲幸运5官方开奖结果体彩网:avoidable costs.

What Is Another Name for a Relevant Cost?

Relevant costs are som🍨etimes also called avoidable costs or differential costs.

What Are the Two Characteristics of Relevant Costs?

Relevant costs are avoidable and can di🐓ffer depending 🌠on which action is taken.

Why Is Relevant Cost Important?

All costs in a business are important. Relevant costs stand out b♈ecause they haven’t been incurred yet, can be avoided, and are only pursued if it’s believed the action will be profitable. Companies keep track of these costs and jobs could be in jeopardy if they don’t pay off.

What Is the Difference Between Relevant Cost and Sunk Cost?

Relevant costs are future expenses꧃ related to a specific decision. They can be avoided and differ depending on which choice is taken. Sunk costs, on the other hand, are existing expenses that have already been incurred and are unrecoverable.

The Bottom Line

Relevant costs are avoidable costs that are incurred only when making specific business decisions. Many of the decisions company management make have a financial impact, such as, for example, choosing whether to shut down an operation or pursue an opportunity. The option taken has financial implications in terms of expenses and revenues and it's up to management to work out, using all available data, which path is likely to be more profitable.

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