Irrelevant cost

From CEOpedia | Management online

An irrelevant cost is a cost that will not change as the result of a management decision. However, the same cost may be relevant to a different management decision. Consequently, it is important to formally define and document those costs that should be excluded from consideration when reaching a decision. For example, the salary of an investor relations officer may be an irrelevant cost if a management decision relates to issuing a new product, since dealing with investors has nothing to do with that particular decision. However, if the board of directors is considering taking the company private, then it may no longer need an investor relations officer; in the latter case, the salary of the investor relations officer is highly relevant to the decision. As another example, the rent for a production building is irrelevant to the decision to automate a production line, as long as the automated equipment is still housed within the same facility.

Irrelevant costs are costs which are nonpartisan of the divers alternatives or decision. They are not included in taking a decision. Irrelevant costs can be ranked into two rubrics: sunk costs and costs which are same sort of for various options. Sunk cost is cost incurred. It can not be altered by any present or coming act. For instance if a new engine is bought to change an former one; the cost of former engine would be sunk cost. The example of irrelevant cost is fixed costs, sunk costs or book values. Irrelevant and sunk costs are to be left out when determining on a coming process of act. On the contrary, these costs can direct to an erroneous decision. For instance, at the time of decision to exchange typewriters by computers, all company passed over the cost of typewriters, although more or less of them were purchased a little time earlier before the decision. A couple of company could have been wrong and retarded the computerization decision, if the cost of typewritters had been kept in mind. Sunk costs contain costs like insurance that has already been settled up by the coropration, therefore it must not be impacted by any coming decision. Unavoidable costs are those that the corporation will endure without regard for the decision it takes.

Kinds of Irrelevant Costs

Here are the exampeles of the irrelevant cost:

  • Sunk Cost
  • Committed costs
  • Non-cash expenses
  • Overheads

Sunk Cost

Sunk costs pass to the expenses which have been endured in a prior period . Sunk costs are irrelevant, as they do not impact the coming cash flows.The should have no impact on decisions about the future (Garrison R. and other 1994, no.6)

Committed costs

Coming costs, which must not be changed, are not relevant as they will have to be endured regardless of the decision took.

Non-cash expenses

Non-cash expenses same as depreciation and amortization are not categorized as relevant as they do not impact the cash flows of a company.

Overheads

General and administrative overheads, that are not impacted by the replacement decisions, are not relevant (S. Bragg, 2018)


Examples of Irrelevant cost

  • Rent for a production building: Rent for a production building is irrelevant to the decision to automate a production line, as long as the automated equipment is still housed within the same facility.
  • Salary of an investor relations officer: The salary of an investor relations officer may be irrelevant if a management decision relates to issuing a new product, since dealing with investors has nothing to do with the decision.
  • Cost of utilities: The cost of utilities, such as electricity and water, may be irrelevant to a decision to outsource a manufacturing process, since the same utilities will still be used regardless of the decision.
  • Cost of raw materials: The cost of raw materials is irrelevant to the decision to purchase new machinery, since the same raw materials will be used regardless of the decision.
  • Cost of labor: The cost of labor is irrelevant to the decision to automate a process, since the cost of labor will remain the same regardless of the decision.

Advantages of Irrelevant cost

One of the advantages of irrelevant costs is that they can be excluded from consideration when making a decision, allowing a more informed and efficient decision-making process. Other advantages of irrelevant costs include:

  • Cost savings: Irrelevant costs do not need to be taken into account and therefore can be excluded, resulting in cost savings.
  • More accurate decision-making: By excluding irrelevant costs, management is able to focus on relevant costs and make a more accurate decision.
  • Improved efficiency: Not having to consider irrelevant costs can lead to improved efficiency in decision-making as it eliminates the need to spend time and resources on costs that are not relevant to a particular decision.
  • Reduced risk: By not having to consider irrelevant costs, management can reduce the risk of making an uninformed decision.

Limitations of Irrelevant cost

Despite their usefulness, irrelevant costs have certain limitations. These include:

  • Their definition is often subjective, as two different people may define the same cost differently. This can lead to confusion and disagreement when making a decision.
  • They may not be fully considered when making a decision. For example, an irrelevant cost may still have an indirect impact on a decision, such as a reduced profit margin or higher expenses, that may not be taken into account.
  • They may change over time, as the circumstances and objectives of the decision-maker change. If the cost is not re-evaluated regularly, it may become relevant at some point in the future.
  • They may not be applicable to all decisions. A cost that is irrelevant to one decision may be relevant to another. Therefore, it is important to consider each decision on its own merits and determine which costs are relevant and which are not.

Other approaches related to Irrelevant cost

  • Activity-based costing (ABC): This approach takes into account the cost of specific activities related to a product or service and assigns those costs to the product or service based on its usage of those activities.
  • Target costing: This approach involves setting a target cost for a product or service before the product development process begins. This approach can be used to identify and eliminate irrelevant costs before the product is even developed.
  • Value engineering: This method looks at the costs associated with a product or service and evaluates them to determine if they are actually necessary for the product or service to be of value to the customer. Any unnecessary costs are eliminated.

In conclusion, there are a variety of approaches which can be used to identify and eliminate irrelevant costs. Activity-based costing, target costing, and value engineering are three of the most common approaches used to identify and eliminate irrelevant costs. These approaches can help organizations streamline their operations and maximize their profits by eliminating costs that are not necessary.


Irrelevant cost — recommended articles
Differential costing — Differential cost — Allocated cost — Absorbed costs — Cost per unit — Normal cost — Committed cost — Functional budget — Segment margin

References

Author: Natalia Bielak

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