relevant cost

An expected future cost that varies with alternative courses of action. Decision making involves choosing between such alternatives and to make the best choice a manager needs to identify the future cash flows for each decision. Costs that have already been incurred as a result of past decisions ( sunk costs) are not relevant for decision making. Likewise, a future cost that will not be changed by a decision is irrelevant to that decision. See differential analysis.

An understanding of relevant costs is particularly important for the following types of decision:

• special selling-price decisions;

• product-mix decisions when capacity constraints exist;

• decisions on replacement of equipment;

• outsourcing (make or buy) decisions;

• decisions on whether to drop a product or close a department.

Example

A company manufactures doors. It has 10 doors in stock that have been difficult to sell as the design is not popular with customers. The doors were completed last year and the following costs have been identified by a manager:

All of these costs were incurred last year. A new customer has offered to purchase the doors for a total of £400 if they can be modified by the fitting of specialist locks. These locks will have to be purchased at a cost of £100 and the labour cost of fitting them will be £60. Finally, the delivery cost of the doors will be £50.

Before deciding whether to accept the customer's offer, managers will have to identify the relevant costs of having the doors modified.

- Irrelevant costs

- Relevant costs