Question

1. Identify relevant costs, irrelevant costs, and sunk costs. Give an example of each.

2. In 150 words or fewer, explain the difference between relevant costs, irrelevant costs, and sunk costs.

Answer 1

1. Relevant costs-

A relevant cost is a cost which differs between two alternatives. It is extremely useful for making managerial decisions.

For example, the management is considering 2 options while deciding whether to make a product in house or buy it. The buying option results in an additional shipping cost of $10 per unit. This cost is relevant to the decision as it results in incremental cash outflow.

Irrelevant costs-

​An irrelevant cost is a cost which does not relate to a management decision. It does not impact management decision in any manner.

For example, The company is making a decision on whether to shut off the cosmetology unit in a health care industry. The director's fee in this regard is an irrelevant cost as it will not be affected by the shut down of the unit.

Sunk costs-

​​ A sunk cost is an irrecoverable cost which has already been incurred. They are not considered while decision making.

For example, if a company leases a plant and pays $50000 yearly, this cost is sunk and is irrelevant to decision making. Sunk costs are also referred to as period costs.