1.1.1 Differential cost is the
difference between the cost of
two alternative decisions, or
of a change in output levels.
1.2 Opportunity Cost
1.2.1 Opportunity cost is an important
concept in decision making. It
represents the best alternative that
is foregone in taking the decision.
The opportunity cost emphasises
that decision making is concerned
with alternatives and that the cost
of taking one decision is the profit
or contribution foregone by not
taking the next best alternative.
1.3 Avoidable costs
1.3.1 Avoidable costs are the specific
costs associated with an activity
that would be avoided if that
activity did not exist.
2 Non -
2.1 Costs which are not
relevant to a decision
are known as non
relevant costs and
include: sunk costs;
committed costs; non
cash flow costs;
overheads; and net
2.2 Sunk costs
2.2.1 A cost that has already been incurred and
thus cannot be recovered. A sunk cost
differs from other, future costs that a
business may face, such as inventory
costs or R&D expenses, because it has
already happened. Sunk costs are
independent of any event that may occur
in the future.
18.104.22.168 When making business or investment decisions, individuals and
organizations typically look at the future costs that they may incur, by
following a certain strategy. A company that has spent $5 million building a
factory that is not yet complete, has to consider the $5 million sunk, since
it cannot get the money back. It must decide whether continuing
construction to complete the project will help the company regain the sunk
cost, or whether it should walk away from the incomplete project.
2.3 Committed cost
2.3.1 A committed cost is an investment that a business
entity has already made and cannot recover by any
means, as well as obligations already made that the
business cannot get out of. You should be aware of
which costs are committed costs when you are
reviewing company expenditures for possible cutbacks
or asset sales.
22.214.171.124 if a company buys a machine for $40,000 and also issues a
purchase order to pay for a maintenance contract for $2,000 in
each of the next three years, all $46,000 is a committed cost,
because the company has already bought the machine, and has a
legal obligation to pay for the maintenance. A multi-year property
lease agreement is also a committed cost for the full term of the
lease, since it is extremely difficult to terminate a lease agreement.
2.4 Fixed costs
2.4.1 A cost that does not change with an increase
or decrease in the amount of goods or
services produced. Fixed costs are expenses
that have to be paid by a company,
independent of any business activity. It is one
of the two components of the total cost of a
good or service, along with variable cost.
126.96.36.199 An example of a fixed cost would be a company's
lease on a building. If a company has to pay $10,000
each month to cover the cost of the lease but does
not manufacture anything during the month, the lease
payment is still due in full. In economics, a business
can achieve economies of scale when it produces
enough goods to spread fixed costs. For example, the
$100,000 lease spread out over 100,000 widgets
means that each widget carries with it $1 in fixed
costs. If the company produces 200,000 widgets, the
fixed cost per unit drops to 50 cents.
2.5 Net Book Values
2.5.1 Net book values are not relevant costs
because like depreciation, they are
determined by accounting conventions
rather than by future cash flows.