Identifying Relevant Cost

A managerial accounting term that is used to describe costs that are specific to management's decisions. The concept of relevant costs eliminates unnecessary data that could complicate the decision-making process.Relevant costs are costs that change with respect to a particular decision. Sunk costs are never relevant. Future costs may or may not be relevant. If the future costs are going to be incurred regardless of the decision that is made, those costs are not relevant. Committed costs are future costs that are not relevant. Even if the future costs are not committed, if we anticipate incurring those costs regardless of the decision that we make, those costs are not relevant. The only costs that are relevant are those that differ as between the alternatives being considered.

Unavoidable costs are never relevant and include:

 Sunk costs.

 Future costs that do not differ between the alternatives.

Terminology:

o Incremental Cost – the additional total cost incurred for an activity

o Differential Cost – the difference in total cost between two alternatives

o Incremental Revenue – the additional total revenue from an activity

o Differential Revenue – the difference in total revenue between two alternatives

Potential Problems with Relevant-Cost Analysis:

o Avoid incorrect general assumptions about information, especially:

0 “All variable costs are relevant and all fixed costs are irrelevant”

0 There are notable exceptions for both costs

Problems with using unit-cost data:

0 Including irrelevant costs in error

0 Using the same unit-cost with different output levels

o Fixed costs per unit change with different levels of output

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