In accounting, what is meant by relevant costs?
Relevant costs are those costs that will make a difference in a decision. Relevant costs are future costs that will differ among alternatives.
We can demonstrate relevant costs with the following situation. A company is deciding whether or not to eliminate a product line. The product line accounts for approximately 4% of the company’s activities. If the product line is eliminated, the officers of the corporation will continue to receive the same salaries and the central office expenses will not change. The product line managers and other employees working directly on the product line will be terminated. Hence, their salaries will be eliminated.
The salaries of the product line managers and other employees whose salaries will be eliminated are relevant to the decision. If these salaries are $700,000 with the product line and $0 without the product line, the $700,000 of savings is relevant. Those cost savings and other possible cost savings will be considered along with the loss of sales revenues.
On the other hand, the officers’ salaries are not relevant in the decision. In other words, it doesn’t matter if the officers’ salaries are $500,000 or $5,000,000. The officers’ salaries will be the same with or without the product line. Similarly, the decision maker does not need to know the amount of its central office expenses, since they will be the same with or without the product line. Expenses from previous years are also irrelevant.
To recap, relevant costs are the future costs that will differ among alternatives. You might use the past costs to help you predict those future costs, but the past costs are otherwise irrelevant to the decision. Accountants refer to the past costs as sunk costs.
About the Author: Harold Averkamp (CPA) has worked as an accountant, consultant, and university accounting instructor for more than 25 years. He is the creator and author of all the content found on AccountingCoach.com. You can read 1,500 testimonials praising his ability to explain accounting in a way that anybody can understand.
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