What Is a Relevant Cost?
Which costs matter when you make a decision, with a worked example.
Home › Accounting Glossary › Relevant Cost
| Include | Future costs, incremental cash costs, opportunity costs |
|---|---|
| Ignore | Sunk costs, depreciation, unchanged fixed overhead |
| Topic | Management accounting · Decision making |
Relevant cost in plain English
Ask of each cost: “Will this cost change because of the decision?” If yes, it is relevant. If it will be the same whichever option you choose, it cannot help you decide, so leave it out.
Worked example
A firm with spare capacity is offered an order for 1,000 units at 20 each. Variable cost is 13 per unit. Absorbed fixed overhead is 6 per unit, but total fixed costs will not change.
- Relevant cost per unit = 13 (variable cost only).
- Absorbed fixed overhead of 6 is irrelevant, because it does not change.
- Contribution per unit = 20 − 13 = 7, so the order adds 7,000 to profit.
If the firm had no spare capacity and would lose normal sales earning a contribution of 10 per unit, that lost contribution would be an opportunity cost, making the relevant cost 13 + 10 = 23, and the order would be rejected.
- Including absorbed fixed overhead that does not change.
- Including sunk costs, or leaving out an opportunity cost.
Frequently asked questions
Is depreciation a relevant cost?
No. It is an allocation of a past cost and not a future cash flow that changes with the decision.
What is the relevant cost of materials already in stock?
It depends on the situation: the replacement cost if the stock would be replaced, the sale proceeds if it could be sold, or zero if it has no other use.
Is an opportunity cost a relevant cost?
Yes. The benefit given up by choosing an option is part of the cost of that option.
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