Since they are the same in all alternatives, they become irrelevant and need not be considered in calculations made for managerial analysis. Irrelevant costs are costs that are not useful or rather not at all considered when a company is making a business decision. However, it doesn’t mean such costs will remain irrelevant for longer and may become relevant if the business environment or priorities change. An irrelevant cost is a cost that will not change as the result of a management decision.
Examples of Irrelevant Cost
Consequently, it is important to formally define and document those costs that should be excluded from consideration when reaching a decision. The book value of fixed assets like machinery, equipment and inventory are another example standard costing system of irrelevant sunk costs. The book value of a machine is a sunk cost which does not affect a decision involving its replacement. Relevant costs are costs that are affected by a managerial decision in a particular business situation.
What are the types of costs in cost accounting?
- It can be noted that fixed costs are often irrelevant because they cannot be altered in any given situation.
- Hence, these costs are important when a statement for costs is prepared; these can be eliminated by looking at the relevancy of the decision-making criteria.
- However, it doesn’t mean such costs will remain irrelevant for longer and may become relevant if the business environment or priorities change.
- The importance of irrelevant costs can be explained in different ways because, on the one hand, it is the expense for which a business cannot produce revenues.
Classifying costs as either irrelevant or relevant, is useful for managers making decisions about the profitability of different alternatives. Costs which stay the same, regardless of which alternative is chosen, are irrelevant to the decision being made. Classifying costs as either irrelevant or relevant is useful for managers making decisions about the profitability of different alternatives. Costs that stay the same, regardless of which alternative is chosen, are irrelevant to the decision being made. An irrelevant cost is a managerial accounting term that represents a cost, either positive or negative, that would not be affected by a management decision. Salary to the advertising campaign team is irrelevant when we are making a business decision to buy specialized equipment for the launching of a new product.
Relevant vs Irrelevant Costs
In other words these are the costs which shall be incurred in one managerial alternative and avoided in another. As the name suggests they are ‘relevant’ for managerial analysis and should be considered in all calculations made for the purpose. The classification of costs between relevant costs and irrelevant costs is important in the context of managerial decision-making. The book value of fixed assets like machinery, equipment, and inventory is another example of irrelevant sunk costs.
In any managerial decision involving two or more alternatives, the prime focus of analysis is to find out which alternative is more profitable. The profitability of alternatives is determined by considering the revenues generated by and costs incurred under each alternative. Some costs may stay the same regardless of which alternative is chosen while some costs may vary between the alternatives. The classification between relevant and irrelevant costs is useful in such situations. Irrelevant costs are costs, either positive or negative, that would not be affected by a management decision.
Irrelevant costs, such as fixed overhead and sunk costs, are therefore ignored when that decision is made. However, it’s critical for a manager to be able to distinguish an irrelevant cost in order to potentially save the business. In other words, these are the costs which shall be incurred in the all managerial alternatives being considered.
Fixed overhead and sunk costs are examples of irrelevant costs that would not affect the decision to shut down a division of a company, or make a product instead of purchasing it from a supplier. Likewise, the wages of employees retained after the sale of a division, would be irrelevant to the decision to sell it. Likewise, the wages of employees retained after the sale of a division would be irrelevant to the decision to sell it.
However, when advertising that same product comes as a business decision, then the salary of the advertising campaign becomes relevant. Relevant costs are affected by a managerial choice in a certain business situation. In other words, these are the costs which shall be incurred in one managerial alternative and avoided in another. It can be noted that fixed costs are often irrelevant because they cannot be altered in any given situation.