Question

Explain a situation you have observed (or read about) in which a firm made a decision considering irrelevant costs or did not consider relevant costs. What was the outcome of the decision, and what could have been done differently?

Answer 1

The costs which are associated with production units or operating are relevant cost – direct material cost, lubricants, supervisor salary, etc.

The costs which are not associated with a particular operation but associated with the whole system are irrelevant costs – salary of office staff, factory rent, etc.

Explanation:

If there is huge investment cost and high amount of fixed cost in an area (like in a foreign country), the firm has to consider only on all those investments interest and fixed costs as these are irrelevant costs, applicable to all the division in that area.

There should not be any consideration of relevant costs – like material costs, labor costs, etc.

This is so because the firm may face a limitation of spending, since there may not be sufficient amount of revenue initially.

Outcome:

If the aggregate of such costs is not affordable, the firm may stop expanding there.

If there is no such limitation, the firm may continue production there.

Different:

The firm may consider different alternatives before considering the final decision. Such as 3 more areas are to be considered for finding those irrelevant costs.