What is Relevant Cost?

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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.

Definition

Relevant cost is a term in managerial accounting that describes costs that will only occur when making specific business decisions. These costs are crucial in the decision-making process as they directly impact the final choice.

Origin

The concept of relevant cost originated in managerial accounting to help businesses eliminate unnecessary data interference during decision-making. As business management theories evolved, relevant cost became an essential tool in decision analysis.

Categories and Features

Relevant costs are mainly divided into two categories: variable costs and opportunity costs. Variable costs change with the decision, such as production costs. Opportunity costs refer to the potential benefits lost when choosing one option over another. The characteristics of relevant costs are that they are future-oriented, avoidable, and directly related to specific decisions.

Case Studies

Case 1: A company considers whether to shut down a loss-making production line. Relevant costs include the operational costs saved and potential lost sales revenue after closure. Case 2: A retailer considers expanding into a new market, where relevant costs include marketing expenses for entering the new market and potential additional revenue.

Common Issues

Investors often mistakenly consider sunk costs as relevant costs. Sunk costs are past costs that cannot be recovered and should not affect current decisions. Additionally, ignoring opportunity costs is a common mistake that can lead to inefficient decisions.

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