Question

Describe and give examples of relevant and irrelevant costs when making short-term business decisions. Also describe relevant and irrelevant non-financial information. Explain why each is relevant or irrelevant.

Answer 1

Relevant cost:

Relevant costs are those costs which are influenced by and relate to a decision. Relevant costs are costs which are incurred if decision is taken otherwise these are avoidable. Relevant cost is future cost.

All variable costs like Direct Material cost, Direct labor cost, Variable overheads, variable selling expenses are relevant costs. Relevant costs are differential costs.

Irrelevant costs are costs which are already incurred and committed and which do not change or are not influenced by a decision. These are sunk costs and are not relevant for decision making. As these costs are sunk, they are excluded while evaluating a decision.

If a manufacturing concern is running above break-even point but has idle capacity, to evaluate a decision whether a special order (at a special price) is to be accepted or not, depreciation may be irrelevant cost. Similarly if the concern has committed a multi-year maintenance contract for machines, the cost of this maintenance contract is irrelevant cost for evaluating this decision.

Relevant Financial Information:

Stakeholders require non-financial information also together with financial information. Relevant financial information is information which will influence decision making by stakeholder holder concerned. For example management or investor will be interested not only on revenue, cost or profit figures but also the information what drives them like revenue drivers, cost drivers. The volume drivers such as number or orders, Order pipeline, number of employees, number of hours, number of training organized are relevant non-financial information for them. In addition to volume drivers other non-financial information like environmental risks, matters related to employees, customers, suppliers, inteliectual property, brand name are relevant and crucial non-financial information for success and long term sustainability.

Non-financial information which has no impact on present and future success of a company are irrelevant non-financial information for stakeholders like management or investor.