Definition of Relevant Cost
Relevant cost refers to those costs that are essential for making specific business decisions and wouldn’t have been incurred if the decision were different. In the realm of managerial accounting, this term is crucial as it helps in focusing on the future costs that can be avoided, rather than dwelling on the expenses that cannot be recovered, known as sunk costs.
Relevant costs are used in myriad scenarios like evaluating whether to continue business operations, recalibrating product lines, or accepting special orders. Imagine you’re deciding whether to keep or kiss goodbye to a business venture. Here, only the costs that can be altered or avoided are your “relevant costs.” Meanwhile, the money already thrown into the abyss of sunk costs should no longer haunt your decision sheets.
Practical Applications of Relevant Cost
Continue Operating vs. Closing Business Units
Determining whether to shut down a business unit involves staring down at the column of relevant costs. Say a chain of tech gadget shops is mulling over closing their vintage calculator line. Relevant costs would include any costs you can cut by stopping the operations, against the potential revenue lost from calculator enthusiasts. If ditching the retro crunchers saves more than it costs, those gadgets might be better off in a museum.
Make vs. Buy Decisions
Every so often, companies stand at the crossroads of making an item in-house or outsourcing it. Consider a furniture maker pondering over crafting their own knobs versus buying from VintageKnobCo. If producing these twisty treasures ramps up costs over purchasing, then it’s time to email an order rather than turning the lathe.
Special Orders: A Last-Minute Curveball
Special orders are like those uninvited guests at a party; they show up unexpectedly, but you need to make room for them if it’s worth your while. For instance, a print shop covered its monthly nut, and along comes a special order for flyers. If accepting this order fills the coffers with minimal additional cost, then why not roll out the welcome mat?
Related Terms
- Sunk Cost: A past expenditure that cannot be recovered and should not influence current decisions.
- Incremental Cost: The additional cost associated with producing an additional unit or making a different business choice.
- Opportunity Cost: The potential benefits lost when choosing one alternative over another.
- Fixed and Variable Costs: Costs that remain constant or vary with the level of output respectively, important in assessing cost behaviors.
Further Reading
For those looking to delve deeper into the intricacies of cost accounting and decision-making in finance, here are a few enlightening tomes:
- “Cost Accounting: A Managerial Emphasis” by Charles T. Horngren - Explore the foundations and applications of cost accounting in management.
- “Managerial Accounting” by Ray H. Garrison, Eric W. Noreen, and Peter C. Brewer - A thorough guide that elaborates on how managerial accounting aids in business decision-making.
Casting light on relevant costs can transform your decision-making from a murky guesswork into a clear, roadmap-led journey. So next time you tally the numbers, invite only those relevant costs to your financial fiesta!
