Relevant Costs and Decision-Making
Relevant costs are future costs that differ between decision alternatives; sunk costs and costs that do not change between options are irrelevant to the decision.
Explanation
In decision-making, only costs and revenues that differ between alternatives matter. Common decisions include make-or-buy (outsourcing), special order pricing, keep-or-drop a segment, and sell-or-process-further. Opportunity cost — the benefit forgone by choosing one alternative over another — is always relevant. Sunk costs (already incurred and irrecoverable) are never relevant. Allocated fixed costs that will continue regardless of the decision are also irrelevant.
Key Points
- •Relevant costs are future costs that differ between alternatives
- •Sunk costs are always irrelevant; opportunity costs are always relevant
- •Common decisions: make-or-buy, special order, keep/drop segment, sell/process further
Exam Tip
Ignore sunk costs completely. Focus only on costs and revenues that change between alternatives, including opportunity costs.
Frequently Asked Questions
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Test your knowledge
Practice scenario-based questions on this topic with detailed explanations.