relevant vs irrelevant costs: Financial Management & Cost Accounting: Lesson 45 CLASSIFICATION OF COSTS

relevant vs irrelevant costs: Financial Management & Cost Accounting: Lesson 45 CLASSIFICATION OF COSTS

irrelevant cost

The analysis should thoroughly examine all costs related to the manufacture of the product, as well as all costs related to the purchase of the product. This analysis should include both quantitative and qualitative factors. The analysis should also separate the relevant costs from the irrelevant costs and examine only the relevant costs. The analysis should also consider product availability and product quality in each of the two scenarios.

opportunity costs

  • It is helpful to the management in making profitability calculation when one or more of the inputs required by one or more of the alternative course of action is already available.
  • It can be done even in a situation where efficient cost – control is in existence.
  • The Institute of Cost Accountants has constituted the Cost Accounting Standards Board to procure suggestions and uniformity in Costing.
  • In other words, these are the costs that must be incurred in one managerial alternative and avoided in another.

When would it be beneficial for someone to sell their intellectual property? Not everyone has the means to implement their creation and may have to turn to someone else to implement it. For example, someone may have invented a unique tool, however, they do not have the means or money to start production or make money on a large scale. That person can see his invention materialize by finding a company that is willing to buy the idea and take it to the market for him. They can pay a full amount for the idea and obtain the legal rights to the invention by filing a patent on it in the name of the company.

Based on the Nature of Expenses

The cost so indicated on the relevant cost statement is valid only at a given level of activity. Experts stated that in relevant costing, period of comparison is often incomplete or incomparable. Timing of cost and benefit is not important in the technique of relevant costing.

The worker gets fixed salary of Rs. 100 per month and incentive Rs. 50 per unit. Then for making 20 units in month, he will get payment of Rs. 2000. Intellectual property can be owned by individuals or companies. Although many companies and individuals maintain their creations, many companies have this intellectual property with the general idea of ​​selling it legally. And there are times when an individual may prefer to sell the intellectual property rather than retain it for themselves. This does not mean that all costs which occur in future aren’t related value.

quantitative and qualitative

Relevant costs are the prices which might change on account of the choice under consideration, the place as irrelevant prices are these which would stay unchanged by the decision. Therefore only relevant value can be included in the investigative framework . A related price can also be outlined as a price whose quantity shall be affected by a call being made. Management ought to believe only future prices and revenues that will differ under each various . Relevant prices are accepted future prices and relevant profits are anticipated future revenues that differ among the many various course of action being thought-about .

Sunk costs are irrelevant,but irrelevant costs are not sunk

Also, ignoring irrelevant information in analysis can save effort and time. To summarize, decision making is an integral part of any business of human life. But business life presupposes the conscious level of decision making instead of rash decision.

They do not make any distinction and make no impact in making selections. Firstly, by mistake, irrelevant prices are taken as relevant costs. They will complicate the situation as well as increase the chance of faults. Secondly, similar unit prices of fixed manufacturing prices are taken for different exercise level. In such instances, the use of related and irrelevant cost becomes very important to find out whether or not the new decision might be profitable or not. Relevant cost of materials is the incremental future cost of utilizing supplies in a proposed enterprise choice.

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For a value item to be related, each the conditions must be current. The authentic payments undergone by an entrepreneur in employing input are known as outlay It includes costs on payments of fuel, rent, electricity, etc. Hence there are several different types of concepts of cost, which have been discussed in the following. Cost is thus another vital concept in the study of business, so, without further ado let us start digging into its concept.

Certain costs which become the part of cost of the product are called product costs. That is it includes all the costs involved in manufacturing the final product. So product cost can be carried forward to future account period. In case of committed fixed cost, there is negligible control of the management the Discretionary fixed costs, are greatly controllable by the management. Discretionary fixed costs can be reduced or even eliminated entirely if the circumstances so require. For example, a comparison of two alternative production methods may result in identical direct material costs for both the alternatives.


If the production is more, the business will pay more and vice versa. With heightened competition in today’s world, companies are urged to make maximum profits. The company’s decision to maximize earnings relies on the behavior of its costs and revenues. Besides the concept of opportunity cost, there are several other concepts of cost namely fixed costs, explicit costs, social costs, implicit costs, social costs, and replacement costs. Question 5 of November 2009-Old Course -“Sunk costs are irrelevant in decision-making, but irrelevant costs are not sunk cost.”Explain with examples. The major intent of relevant costing is to find out the objective cost of a enterprise choice.


They must be different among the alternative course of action. Would you take this as an opportunity to start a discussion or a chat fight may be.

Cost analysis is the classification of the aggregate costs into relevant types. It can be interpreted that, the earnings of the workers is variable unable the output but it is not directly proportionate to the output. A Cost-centre is defined as a location, person or item of equipment , for which costs may be ascertained and used for the purpose of cost control. In this case, the direct material cost will remain the same whichever alternative is chosen. A relevant price can also be outlined as a cost whose amount will be affected by a call being made. Incremental cost must be compared with incremental revenues to take decision.

Relevant Costs are costs which are relevant or useful for decision making. They are those expected future costs that are essenial but difer for alternaive courses of acion. They are future costs which would arise as a direct consequence of the decision under review.

This technique is applicable to all special or non-routine situations. If the correct and accurate results are to be obtained, then proper thought has to be given to the matter. Each cost item apparent or hidden needs proper attention before assumption are built in the solution. It is not proper to proceed on the assumption in the context of relevant costing.

  • It is not proper to proceed on the assumption in the context of relevant costing.
  • Relevant info is the expected future prices and incomes that can differ among the many alternatives related data .
  • The cost of converting raw material into finished goods is called conversion cost.
  • Relevant price, in managerial accounting, denotes to the incremental and pointless value of implementing a enterprise decision.
  • They must be different among the alternative course of action.

A related price is a value that solely relates to a specific management decision, and which is able to change sooner or later on account of that call. The related value idea is extremely helpful for eliminating extraneous data from a specific choice-making process. It refers to the amount of payment made to acquire any goods and services. In a simpler way, the concept of cost is a financial valuation of resources, materials, risks, time and utilities consumed to purchase goods and services.

A direct cost is a cost that is related to the production method of a good or service. During the next quarter only 10,000 units can be produced and sold. Management plans to shut down the plant estimating that the fixed manufacturing cost can be reduced to ₹ 74,000 for the quarter. So long as the incremental revenue is greater than incremental costs, the decision should be in favour of the proposal. Based on the above points the cost schedule will be worked out.

Thus, the cost is nothing but a payment of value that is given in order to utilize the service or goods. The concept of cost gives an indication of the overall resource required to avail the same. These are costs, which are not relevant or useful for decision-making. Q-1A ltd. engaged in manufacturing agricultural machinery is preparing annual budget for the coming year.

It includes cost of direct labour, direct expenses and factory overheads (Hence, it is also referred as “production cost – excluding the cost of direct materials”). Something committed contractually is effectively a sunk-cost and thus is an irrelevant cost for the decision making process under germane consideration. A relevant cost is a cost that only relates to a specific management decision, and which will change in the future as a result of that decision. The relevant cost concept is extremely useful for eliminating extraneous information from a particular decision-making process.

relevant vs irrelevant costs cost is the change in the total cost due to change in the level of activity, technology or production process or method of production. Fixed costs which are incurred primarily to maintain the company’s facilities and its physical existence are called committed fixed costs. Hence, it is clear that commuted fixed cost arise because of decisions of possession of plant, building, equipment etc. Once the building is constructed, plant and equipment are installed the company has to been certain fixed costs – Depreciation, taxes, insurance, rent etc. The management has little or no control over there costs, they can not reduce / change there costs without impairing the organization’s ability to achieve its long term objectives.

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Examples of irrelevant costs are fixed overheads, notional costs, sunk costs and book values.The gamut is wider for irrelevant costs. Irrelevant prices merely are prices that will not affect the choice. By analyzing these kind of irrelevant prices, administration will be wasting their time and efforts as these prices don’t affect the decision they will make. Since related price method takes into consideration solely the relevant costs and relevant revenues, it simplifies the administration decisions. The basic ideas of relevant costing are fairly simple and managers can maybe relate them to private experiences involving monetary choices.

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