Don't have an account? Sign in via your Institution. You could not be signed in, please check and try again. Sign in with your library card Please enter your library card number. Related Content Related Overviews sunk costs differential analysis. Show Summary Details Overview relevant cost. Irrelevant costs The costs incurred last year material, labour, and overheads are not relevant to the decision.
Relevant costs The cost of the locks, the labour cost of fitting them, and the cost of delivery are differential cash flows that will be incurred if the doors are modified. Reference entries relevant cost in A Dictionary of Accounting 4 Length: words. All rights reserved. Apply market research to generate audience insights.
Measure content performance. Develop and improve products. List of Partners vendors. 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. 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. Because these costs have already been incurred, they are "sunk costs" or irrelevant costs.
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. It is worthwhile to do this, as the extra revenue is greater than the extra costs. Example 6: Shut down decision A company has two production lines and its management accounts show the following:.
The company is concerned about the loss that is reported by Production Line B and is considering closing down that line. Therefore, the closure of Production Line B is not a good idea as the revenue lost is greater than the value of the costs saved.
Really, the heart of the matter is the misleading effect of the relatively arbitrary apportionment of the fixed costs. A more useful presentation of the figures for decision-making would be:. Example 7: Make or buy decision A company makes a product which requires two sequential operations Operation 1 and Operation 2 on the same machine. The machine is fully utilised. This would allow production to be increased because the machine has to deal with only Operation 2.
Operation 1 takes 0. Solution: Some care is needed here to ensure all incremental cash flows caused by the decision are taken into account.
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. Assuming output is 1, units, the following would occur ignoring labour and variable overheads which we know to be constant :. Relevant costs. The change in cash flow can be: additional amounts that must be paid a decrease in amounts that must be paid additional revenue that will be earned a decrease in revenue that will be earned.
Sunk costs past costs or committed costs are not relevant Sunk, or past, costs are monies already spent or money that is already contracted to be spent.
Depreciation and book values notional costs are not relevant Depreciation is not a cash flow and is dependent on past purchases and somewhat arbitrary depreciation rates. 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.
Revenues forgone given up because of a decision are relevant If a company decides to keep an asset for use in the manufacture of a new product rather than selling it, then its cash flow is affected by the decision to keep the asset, as it will now not benefit from the sale of the asset. What is the relevant cost of the materials required for manufacture of the new product? The total relevant cost for Material B is:.
Find salaries. Upload your resume. Sign in. Career Development. What are relevant costs? Additional payment amounts A reduction in due payments Additional earned revenue A reduction in revenue earnings. Why are relevant costs important?
Time to develop. Development resources. Time to market. Perception of performance. Types of relevant costs. Special order costs. Opportunity costs. Examples of relevant costs. Special order. Underemployment: A Definitive Guide. Related View More arrow right. Find out what churn rates and retention rates are, how they differ from one another, how to calculate each one with examples and tips for improving both.
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