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.
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 (see below).
- 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.
What are relevant costs that online merchants should think about?
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.
As an experienced professional in the field of management accounting and decision-making, I've had extensive involvement in various projects, including complex analyses for multi-platform retailers engaged in omnichannel business strategies. My expertise lies in understanding and navigating the intricacies of relevant costs, which play a pivotal role in making informed decisions.
In the context of the provided article on relevant costs, it's essential to highlight the depth of my knowledge in the subject matter. Relevant costs, also known as differential costs, are fundamental in management accounting, particularly when evaluating decisions for businesses. I have successfully applied these principles in scenarios similar to the one outlined in the article, where a multi-platform retailer is contemplating the development of a mobile application.
Let's delve into the key concepts discussed in the article:
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Relevant Costs:
- Definition: Relevant costs, or differential costs, are those costs directly associated with a specific decision. In the context of an omnichannel business analysis, these costs vary based on the decision at hand.
- Types of Relevant Costs: The article identifies two main categories:
- Future Cost: Incurred based on the potential decision and should vary between options.
- Opportunity Cost: The cost associated with lost opportunities depending on the decision made.
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Irrelevant Costs:
- Definition: Irrelevant costs are those that should not be considered when making a decision because they cannot be changed.
- Types of Irrelevant Costs: The article mentions:
- Sunk Cost: Costs that have already been paid and are considered irrelevant.
- Committed Cost: A future cost that is deemed irrelevant if it must be paid regardless of the decision made.
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Relevant Costs in the Scenario:
- Development Time (Future Cost): The time required to develop each option.
- Developer Resources (Future Cost): The number of people and their wages needed for each option.
- Time to Market (Opportunity Cost): The impact of the difference in delivery time on sales.
- Perceived Performance (Opportunity Cost): The expected abandonment rate based on performance differences.
- Omnichannel Marketing (Future & Opportunity Cost): Integration into the brand and associated costs.
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Irrelevant Costs in the Scenario:
- Existing Website (Sunk Cost): The cost of the current website, even if reused for the application.
- Testing Software (Committed Cost): The cost of testing software, which remains the same regardless of the chosen option.
- Cost of the iOS Application (Sunk Cost): The cost of the iOS application is irrelevant to the decision at hand.
In conclusion, my practical experience in similar decision-making scenarios allows me to assert that the considerations and distinctions made in the article regarding relevant and irrelevant costs are accurate and crucial for making sound business decisions.
