costs relevant

It is established that historical value just isn’t related, only future cost is related. Any cost, fixed or variable that would be different for a particular course of action being analyzed is relevant for that alternative. \nAny cost, fixed or variable that would be different for a particular course of action being analyzed is relevant for that alternative. Always interesting to see how other people approach management accounting issues, but you need to think how it applies in your own business environment. Looking at the expected additional costs for Crossrail in this artice We should be saying, ‘Are the benefits worth £400 million’ if we take a Relevant Costing approach. The tendency though is to look at how much has already been sent.

Likewise, the wages of employees retained after the sale of a division would be irrelevant to the decision to sell it. The customer indicated interest to buy the product that the materials would be used to produce at $2,000 per unit. It will cost the company $1,600 to convert the materials to the product required by the customer. The relevant cost and revenue are respectively $1,600 and $2,000 per unit . To summarize, decision making is an integral part of any business of human life. But business life presupposes the conscious level of decision making instead of rash decision.

Closing down either production line would save 25% of the total fixed costs. Irrespective of what treatment is used in the company’s management accounts to split up costs, if the total costs remain the same, there is no cash flow effect caused by the decision. A relevant cost in a company is always incurred by the lower management, and on the other hand, is a company, the irrelevant cost is incurred by the higher management. A relevant cost is also known to be told as differential costs. An irrelevant cost is a cost that is always the same regardless of any decisions taken while they are implemented by someone.

types of relevant

A technique you can use to simplify decision making when setting selling prices/considering alternative options that takes out all the complication of things that are not going to change anyway. Because this cost is positive, this means that the company would be losing money if it were to continue in its Jean Jacket product line. Fuzzy should thus shut down its product line and revert to making denim pants. In this case, 60% of the annual rental amounting to $30,000 is relevant cost as it can be saved if the Joggers Division is closed.

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Irrespective of how the company might use the floor space in the factory to generate a return, there is no change in cash flow relating to the rent as a result of the new machine. Say, for example, that 4 hours of labour were simply removed by ‘sacking’ an employee for four hours, one less unit of Product X could be made. Using the contribution foregone figure of $24 is the net effect of losing the revenue from that unit and also saving the material, labour and the variable costs. In this situation however, the labour is simply being redeployed so $24 understates the effect of this, as the labour costs are not saved. This effect is known as an opportunity cost, which is the value of a benefit foregone when one course of action is chosen in preference to another. In this case, the company has given up its opportunity to have a cash inflow from the asset sale.

The company uses straight-line depreciation, while the machine has a useful life of 10 years. Opportunity costs only arise when resources are scarce and have alternative uses. These are costs which would not be incurred if the activity to which they relate did not exist. The emphasis laid on future is because every decision is based on selection of courses of action for the future. A relevant price can also be outlined as a cost whose amount will be affected by a call being made.

  • A matter is relevant if there is a change in cash flow that is caused by the decision.
  • Costs that stay the same, regardless of which alternative is chosen, are irrelevant to the decision being made.
  • For instance, if a company is planning for ten years ahead, then it would consider all types of costs, including the fixed and sunk cost that it might incur.
  • Fuzzy should thus shut down its product line and revert to making denim pants.

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. A relevant cost is any business expense that can be avoided when making specific business decisions.

There is currently 800 hours of idle time available and any additional hours would be fulfilled by temporary staff that would be paid at $14/hour. The material has no use in the company other than for the project under consideration. For example, if a company has two year lease for piece of machinery, that cost will not be relevant to a decision on whether to use that machinery on a new project which will last for the next month.


That decision will make all the relevant costs and revenue on the spot. In the following case study, you will play the role of a consultant that will help a client of yours make an important strategic business decision. This will allow you to apply your knowledge of relevant and irrelevant costs. Irrelevant costs are costs that are not affected by the ultimate decision. In other words, these are the costs which shall be incurred in the all managerial alternatives being considered. Since they are the same in all alternatives, they become irrelevant and need not be considered in calculations made for managerial analysis.

opportunity costs

Relevant costs are expenses directly affected by a particular management decision, while irrelevant costs are expenses not directly affected by a specific management decision. It is important to remember that, though a cost may irrelevant for one management decision, it may be relevant for other management decisions. There are four types of irrelevant costs are the sunk cost which is the cost of the old furniture in the example, the committed cost which cannot be altered as it’s a future cost. Non-cash expenses include the depreciation of an asset and the overheads during the administration work. There is a difference observed in the relevant cost as per each alternative decision.

What is an example of a relevant cost?

These managerial functions often require the bifurcation of costs into various categories. We have already discussed different categories of costs in current chapter – classification of costs. In this article, we would talk about relevant and irrelevant costs – another classification which is based on whether or not a cost can be controlled or affected through managerial decisions. A future cost has additionally to be different within the different different to creating it a related cost necessary for choice making. In different phrases, the prices which don’t change with the choice scenario are irrelevant costs not thought-about by management.

The figure has to be written off, no matter what possible alternative course of action might be chosen in future. Please note that whether the equipment is scrapped or used for production purposes, the $40,000 would still be written off. This cost cannot be changed as a result of future decision and hence is regarded as sunk cost and is irrelevant in decision making.

What Are Irrelevant Costs?

Sunk costs include historical costs that have been taken up or paid by the company, hence will not be affected by future decisions. Unavoidable costs are those that the company will incur regardless of the decision it makes. Good examples include committed fixed costs such as insurance and current depreciation. Cost data is important since they are the basis in making decisions that are geared towards maximizing profit, or attaining company objectives.

\nGenerally speaking, most https://1investing.in/ costs are relevant because they depend on which alternative is selected. Opposite of relevant costs are irrelevant costs, i.e. the costs that will not be affected by any decision. Purchase of property, machinery, and hired staff are all decisions taken and hence are considered irrelevant costs for any future decision making.

Machine running costs – the machine is already fully utilised on Operations 1 and 2 and will remain fully utilised, but only on Operation 2. Therefore, the machine running costs will not change, so are not relevant to the decision. This is not worthwhile as incremental costs exceed incremental revenues.

What is relevant and irrelevant cost?

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.

An incremental or differential cost is a cost that has been added to a previously understood expense. A committed cost is any cost that is reserved for future business. A non-cash cost is a cost that results from a reduction in the value of assets. Overhead costs are a part of general business operations that keep the business functioning. Examples of relevant costs are marginal or variable cost, specific or avoidable fixed costs, incremental costs, opportunity costs, out of pocket costs etc. On the other hand, the irrelevant costs are general or absorbed fixed costs, committed costs, sunk costs etc.

Managers have to figure out the best way to utilize these capacities. Keeping in view points and , the items should be sold through normal distribution channels which will involve a relevant and irrelevant cost cost of Rs.2 (i.e. Rs.3 – Rs.1) per unit. Hence, the minimum recommended price is more than Rs.2 per unit so that there may be some addition to the profit of the company. Annual directors fee is irrelevant cost because it shall stay the same even if dental care is disposed off.