Relevant costs are future costs that will differ between two or more alternative actions. Expressed another way, relevant costs are the costs that will make a difference when making a decision.
Past costs may help you predict and estimate the future costs, but the past costs are otherwise irrelevant to the decision. That is why accountants will refer to a past cost as a sunk cost.
Examples of Relevant Costs
Assume that a company has five product lines: A, B, C, D, and E. Since E accounts for only 5% of the company's sales, the company is deciding whether to eliminate E. If E is eliminated, the compensation of E's employees and other expenses directly associated with E (amounting to $400,000) will be eliminated. However, the company's other expenses (executives' compensation, depreciation, general administration) will not be reduced.
The $400,000 of costs that are directly associated with E are relevant costs, since the company will see its total costs decrease by $400,000 when E is eliminated. Since the company's other expenses will not change, the company's other expenses are not relevant. In other words, it doesn't matter for the decision to eliminate product line E whether the company's other expenses are $500,000 or $5,000,000.
I bring forth my expertise in managerial accounting and financial decision-making to shed light on the concept of relevant costs, a crucial aspect in making informed business decisions. As an enthusiast with a comprehensive understanding of the topic, I draw upon a background that includes academic training, professional experience, and a continuous commitment to staying abreast of industry developments.
Relevant costs are future expenditures that play a pivotal role in differentiating between alternative courses of action. The emphasis on future costs is integral, as it underscores the forward-looking nature of decision-making. Past costs, while potentially aiding in predicting future expenses, are deemed irrelevant in this context. The rationale behind this distinction is grounded in the concept of sunk costs. Sunk costs are expenditures that have already been incurred and cannot be recovered, making them immaterial to decisions about the future.
In the realm of relevant costs, a prime example is illustrated through the scenario of a company with five product lines—A, B, C, D, and E. In contemplating the elimination of product line E, the focus is on costs that will be directly impacted by this decision. The $400,000 associated with E, including employee compensation and other specific expenses, represents relevant costs. These costs will cease to exist if product line E is eliminated, leading to a tangible reduction in the company's total costs.
Conversely, the company's other expenses, such as executives' compensation, depreciation, and general administration, will remain unaffected by the elimination of product line E. As a result, these costs are deemed irrelevant in the decision-making process. The key principle here is that relevant costs are those that will change based on the alternative chosen, influencing the overall cost structure of the company.
In summary, the concept of relevant costs is rooted in a forward-looking perspective, focusing on future expenditures that will vary across alternative actions. It is essential for decision-makers to discern between relevant and irrelevant costs to make sound choices that positively impact the financial well-being of the organization.
Definition: Relevant cost, also called differential cost, is a management accounting term decsribing costs that pertain to a particular decision. Relevant costs will vary based on the context of the decision, such as an omnichannel business analysis by a multi-platform retailer.
Relevant costs are costs that differ between alternatives. When making the decision, the company should consider relevant costs. An avoidable cost is a cost that can be eliminated, in whole or in part, by choosing one alternative over another.
A relevant cost (also called avoidable cost or differential cost) is a cost that differs between alternatives being considered. In order for a cost to be a relevant cost it must be: Future. Cash Flow.
There are four types of relevant costs that categorize how these costs are relevant to a company's operations. They include future costs, opportunity costs, avoidable costs, and incremental costs.
Relevant costs are costs that will be affected by a managerial decision.Irrelevant costs are those that will not change in the future when you make one decision versus another. Examples of irrelevant costs are sunk costs, committed costs, or overheads as these cannot be avoided.
Relevant costs are those expected future costs that differ among alternative courses of action – that is the cost is pertinent to the decision being made. This idea of relevance focuses on two factors: the cost must be a future cost (not sunk) and the cost must differ among alternative courses of action.
Increases or decreases in cash flows caused by a project are relevant. So, if an old product is discontinued three years early to make room for a new product, the revenue and cost decreases relating to the old product are relevant, as are the revenue and cost increases on the new.
Relevant costs: Costs that should be considered and included in your analysis when deciding on a future course of action. Relevant costs are future costs — costs that you would incur, or bring upon yourself, depending on which course of action you take.
For example, the cost of replacing machines or core components. Replacement cost is one of the firm's relevant costs because a firm can avoid them by taking good care of its equipment and machinery. Opportunity cost is another example of a relevant cost since it can be avoided.
Relevant costs in accounting are considered to be avoidable costs, which are costs that can be reduced by discontinuing an activity that generates these costs. Relevant costs will vary between multiple options being considered by a company or business entity.
Relevant costs and revenues are those future costs and revenues that will be changed by decision while irrelevant costs and revenues are those costs and revenues that will remain unchanged irrespective of the decision made.
Answer and Explanation: The costs that are relevant to decision-making are relevant costs such as avoidable costs, incremental costs, opportunity costs, and future cash flows.
Costs that are always relevant in decision-making are: c. avoidable costs. This is the case because any cost that can be avoided is needed to be known for the best decision that a company can make. Variable costs are a type of this cost and are very relevant to the business.
Sunk costs are the costs which have been created by a decision that was made in the past and cannot be changed by any decisions that will be made in the future. A sunk cost cannot be recovered and are considered irrelevant for future decision making.
There are two kinds of costs, fixed and variable. Fixed and variable costs impact the business in different ways but both are important in making the business profitable.
For example, let's say you're considering an investment in automated production equipment that could allow you to reduce or redistribute your workforce. As you weigh the pros and cons of the decision, you'll categorize the workers' wages as a relevant cost that the equipment could reduce or eliminate in the future.
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.
Fixed costs can be relevant but they have to be related to a specific decision. On the other hand, fixed costs that are general in nature (i.e. fixed costs that we incur regardless of whichever decision is made), would not be considered relevant.
Variable costs are also relevant costs for management decision making. Variable costs include Direct Material costs, Direct labour costs and variable overhead costs. Note that whereas all variable costs vary with the level of activity or output level, the fixed costs remain fixed within relevant range of activity.
Introduction: My name is Wyatt Volkman LLD, I am a handsome, rich, comfortable, lively, zealous, graceful, gifted person who loves writing and wants to share my knowledge and understanding with you.
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