What is meant by relevant costs in accounting?


What is meant by relevant costs in accounting?

Relevant costs are the costs that are crucial to making a decision. These are future costs that tend to be different for different compatible or incompatible alternatives.

Let us demonstrate relevant costs with this situation. A company has to make a decision whether to stick to a certain merchandise or to put an end to its production. The merchandise is responsible for around 4% of the company’s activities. If the merchandise is abolished, the officers of the company will continue to receive their remuneration and the expenditure of the central office will remain the same. However, the workers and managers working with the merchandise directly will have to be fired. So, their remuneration will also be negated.

The remuneration of the managers and workers working directly with the merchandise are crucial and hence relevant to the decision. If this remuneration is $700,000 with the merchandise continued and $0 with the merchandise abolished, then $700,000 worth of savings are relevant to the company. Those cost savings and other cost savings will be taken into account alongside the loss of sales revenues.

On the contrary, the remuneration of the officers are not relevant to making the decision. So to speak, it does not matter whether their remuneration adds up to $500,000 or even $5,000,000. Their remuneration will not be affected whether the merchandise is continued or abolished. Similarly, the persons designated to take the decision will not be interested in knowing the expenditure of the central office since it will remain the same whether the commodity is continued or abolished. Expenditure of the past years are also not relevant to the decision.

To sum it up, relevant costs are the future costs that will be different for different scenarios. You can employ the past costs to forecast the future costs but the past costs will still remain irrelevant to the decision. The past costs are referred to as sunk costs by accountants.

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