What Is an Irrelevant Cost?
Irrelevant costs are costs, either positive or negative, that would not be affected by a management decision. Irrelevant costs, such as fixed overhead and sunk costs, are therefore ignored when that decision is made. However, it’s critical for a manager to be able to distinguish an irrelevant cost in order to potentially save the business.
Key Takeaways
- Irrelevant costs are costs that won’t be affected by a managerial decision.
- Relevant costs are costs that will be affected by a managerial decision.
- Irrelevant costs are those that will not change in the future when you make one decision versus another.
- Examples of irrelevant costs are sunk costs, committed costs, or overheads as these cannot be avoided.
- There is no correct answer for each business, it will often alter per situation.
Understanding Irrelevant Costs
Classifying costs as either irrelevant or relevant is useful for managers making decisions about the profitability of different alternatives. Costs that stay the same, regardless of which alternative is chosen, are irrelevant to the decision being made.
Because an irrelevant cost may be a relevant cost in a different management decision, it is important to formally define and document costs that should be excluded from consideration when reaching a decision.
It helps to understand the difference between irrelevant and relevant costs to make a critical business decision. These costs can either make your company more profitable or put the company under. These small decisions are very crucial in day-to-day business. Here are some examples of why irrelevant or relevant costs must be considered:
- Shutting down a specific division within the business,
- Accepting a special order at a lower or higher price,
- Outsourcing a product or making it in-house,
- Selling a half-finished product or continue processing it.
It can be noted that fixed costs are often irrelevant because they cannot be altered in any given situation.
Types of Irrelevant Costs
Fixed overhead and sunk costs are examples of irrelevant costs that would not affect the decision to shut down a division of a company, or make a product instead of purchasing it from a supplier. For example, if a company bought a machine that broke and could not be returned, this sunk cost would be irrelevant to the decision to replace the machine or get a supplier to do the manufacturing. Likewise, the wages of employees retained after the sale of a division would be irrelevant to the decision to sell it.
The book value of fixed assets like machinery, equipment, and inventory is another example of irrelevant sunk costs. The book value of a machine is a sunk cost that does not affect a decision involving its replacement.
Examples of irrelevant costs:
- Sunk costs: Expenditures which have already been incurred
- Committed costs: Future costs which cannot be altered
- Non-cash expenses: Depreciation and amortization
- Overheads: General and administrative overheads
Irrelevant Costs vs. Relevant Costs
A relevant cost is any cost that will be different among various alternatives. There is seldom a “one-size fits all” situation for relevant or irrelevant costs. This is why they are often called differential costs. They differ among different alternatives.
Relevant costs are affected by a managerial choice in a certain business situation. In other words, these are the costs which shall be incurred in one managerial alternative and avoided in another.
Examples of relevant costs include:
- Future cash flows: Cash expenses which will be incurred in the future,
- Avoidable costs: Only the costs which can be avoided in a certain decision,
- Opportunity costs: Cash inflow which would have to be sacrificed,
- Incremental Costs: Only the incremental or differential costs related to the different alternatives.
FAQs
Irrelevant costs are those that will not change in the future when you make one decision versus another. Examples of irrelevant costs are sunk costs, committed costs, or overheads as these cannot be avoided. There is no correct answer for each business, it will often alter per situation.
What is an example of an irrelevant cost? ›
Fixed overhead and sunk costs are examples of irrelevant costs. For instance, the book value of a company's equipment and machinery cannot change regardless of the managerial decision that is reached.
What is an example of relevance cost? ›
If ABC buys the press, it will eliminate 10 scribes who have been copying the books by hand. The wages of these scribes are relevant costs, since they will be eliminated in the future if management buys the printing press.
Is salary an irrelevant cost? ›
Examples of Irrelevant Costs
For example, the salary of an investor relations officer may be an irrelevant cost if a management decision relates to issuing a new product, since dealing with investors has nothing to do with that particular decision.
What is relevant vs irrelevant in accounting? ›
Relevant costs and revenues are those future costs and revenues that will be changed by decision while irrelevant costs and revenues are those costs and revenues that will remain unchanged irrespective of the decision made.
What is the example of relevant and irrelevant? ›
Irrelevant means not related to the subject at hand. If a rock star becomes irrelevant, it means people are not relating––or even listening––to his music anymore. It isn't part of what people are thinking or talking about. The opposite is relevant, meaning related.
What are 5 examples of cost? ›
Raw material, wages on labor, production overheads, rent on the factory, etc. Marketing costs, sales costs, audit fees, rent on the office building, etc.
What is relevance for example? ›
Relevance is simply the noun form of the adjective "relevant," which means "important to the matter at hand." Artists and politicians are always worried about their relevance. If they are no longer relevant, they may not keep their job.
What is an example of relevance in accounting? ›
Example #1
If a company wants to take a loan from a bank, then the bank will want to know first whether the company will be able to pay them back the loan with interest. Therefore, the company's financial statements should be relevant for the bank in making its decision regarding granting a loan to the company.
Is rent a relevant cost? ›
Looking into our sunk and fixed overhead costs we see that the salaries of those who work outside the division, costs of existing equipment, and rents paid to maintain the facility will not change. Therefore, these are irrelevant costs.
Fixed costs, such as a factory lease or manager salaries, are irrelevant because the firm has already paid for those costs with prior sales.
Are sunk costs irrelevant? ›
In business, sunk costs are typically not included in consideration when making future decisions, as they are seen as irrelevant to current and future budgetary concerns. Sunk costs are in contrast to relevant costs, which are future costs that have yet to be incurred.
Why joint costs are irrelevant for decision-making? ›
In a sense, joint costs are sunk costs with respect to this decision, and will not influence future processing decisions. Thus joint costs incurred prior to the split-off point are irrelevant to the decision whether to process further after the split-off point.
Are fixed cost always irrelevant? ›
False. Even though fixed costs are often irrelevant, there are times they become relevant. Fixed costs become relevant if they change based on a decision being taken. For example, rent is a fixed cost.
What is relevant and in relevant cost? ›
'Relevant costs' can be defined as any cost relevant to a decision. A matter is relevant if there is a change in cash flow that is caused by the decision. The change in cash flow can be: additional amounts that must be paid.
What is an irrelevant cost quizlet? ›
Irrelevant Costs: are the same for all alternatives and are ignored. Irrelevant costs include: sunk costs: costs that have already been incurred and are irrevocable; cannot be recovered with any decision.
What are 4 examples of cost? ›
Examples of fixed costs are rent and lease costs, salaries, utility bills, insurance, and loan repayments. Some kinds of taxes, like business licenses, are also fixed costs.
What is an example of a cost that is not avoidable? ›
An unavoidable cost is a cost that is still incurred even if the activity is not performed. Some examples include depreciation on equipment, property taxes, lease payments, interest expense, etc. These costs are often considered fixed costs.
What costs are always relevant what costs are never relevant? ›
An avoidable cost is a cost that can be eliminated, either in whole or in part, by choosing one alternative over another. Avoidable costs are ALWAYS RELEVANT. An unavoidable cost is a cost that exists under all decision alternatives. Unavoidable costs are NEVER RELEVANT.
