Scribd
Upload
59 views3 pages

What Is Relevant Cost

The document discusses relevant cost, which refers to avoidable costs incurred from specific business decisions. It provides examples of relevant costs in decisions like continuing or closing business units, making or buying components, and accepting special orders. There are also sunk and committed costs that are irrelevant to decisions. The document outlines relevant and irrelevant costs to consider in developing a mobile app.

Uploaded by

feliceserapio27
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
59 views3 pages

What Is Relevant Cost

The document discusses relevant cost, which refers to avoidable costs incurred from specific business decisions. It provides examples of relevant costs in decisions like continuing or closing business units, making or buying components, and accepting special orders. There are also sunk and committed costs that are irrelevant to decisions. The document outlines relevant and irrelevant costs to consider in developing a mobile app.

Uploaded by

feliceserapio27
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 3

What Is 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.

Example of Relevant Cost


Assume, for example, 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.

What types of relevant costs are there?


Relevant costs are generally divided into two categories

 Future Cost- Incurred in the future based on the potential decision made. This should vary from
decision option to decision option. If this does not change based on the decision, then it is an
irrelevant cost.
 Opportunity Cost - The cost in lost opportunity depending on the decision made.

Are there irrelevant costs?


Yes, irrelevant costs are those that should not be considered when making a decision because they can not
be changed:

 Sunk Cost - Costs that have already been paid are considered irrelevant.
 Committed Cost - A future cost that is considered irrelevant. If the future cost must be paid
regardless of the decision made then it is irrelevant.

Types of Relevant Cost Decisions

 Continue Operating vs. Closing Business Units


A big decision for a manager is whether to close a business 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 stores 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


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 variable costs incurred by the manufacturer to make the wood
cabinets and the price paid to the outside vendor. If the vendor can provide 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 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 labor
costs. Fixed costs, such as a factory lease or manager salaries, are irrelevant because the firm 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 avoidable costs.

Scenario
Executive management at a company decides that they want to develop a mobile application for Android-
based mobile devices. They are presented with two options by the technical team: A web application
wrapped to look like a mobile application or a mobile application written for Android. Each decision has
several relevant costs:

 Development Time (Future cost) - How much time will it take to develop each option?
 Developer Resources (Future cost) - How many people, and at what wage, are required to build
each option?
 Time to Market (Opportunity cost) - How much will a difference in delivery time impact sales,
and what is the difference?
 Perceived Performance(Opportunity cost) - Is one option better performing than the other, and
what is the expected abandonment rate based on that performance difference?
 Omnichannel Marketing(Future & Opportunity cost) - Can one option fit the overall brand
experience better than the other, and is there a cost associated with integrating the application into
the brand?

There are also irrelevant costs that should be ignored:

 Existing Website (Sunk cost) - The cost of the current website, even if it were reused for the
application, is irrelevant. Any cost mitigation it provides would be accounted for in development
time and resources.
 Testing Software (Committed cost) - Regardless of the option chosen, the same testing software
will be used.
 The cost of the iOS Application (Sunk cost) - Like the existing website, the cost of the iOS
application is irrelevant to this decision.

Key Takeaways

 Relevant costs are only 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.

References
Tuovila, A. (2021, January 29). What Is Relevant Cost in Accounting, and Why Does It Matter. Retrieved
from https://www.investopedia.com/terms/r/relevantcost.asp#:~:text=Relevant%20cost%20is
%20a%20managerial,complicate%20the%20decision%2Dmaking%20process.
What is relevant cost? How to measure and weigh business decisions. Retrieved from
https://www.bigcommerce.com/glossary/relevant-cost/

You might also like