Relevant Costs-Its Importance or Function or Features

Examination questions often touched on relevant cost. It tests the candidates whether they appreciate them in making short term decisions

Understanding relevant costs is important once we realize that there are many areas where relevant costs concepts are applied namely:

· Limiting factor due to scarce resources;

· Make or Buy decision;

· Accept or Reject special order;

· To continue or discontinue or shut down decisions;

· Pricing

In all the above situation, management needs sufficient and relevant information make the correct decisions. Therefore it leads to the need to understand what really is relevant costs.

A relevant cost:

· Relates to future expected costs that will differ with each alternative used.

· Because of the difference amongst alternative, hence it has a bearing on the decision to be made.

· Irrelevant costs simply are costs that will not affect the decision. By analyzing these type of irrelevant costs, management will be wasting their time and efforts as these costs do not affect the decision they are going to make.

Some of the features or criteria of Relevant costs are as follows:

a. Relevant cost is a cost that will be incurred in the future. Historical costs are sunk costs which has no relevancy in the decision making.

b. The costs must differ between alternatives. If a cost is the same whether we choose alternative A or B then this is an irrelevant cost. A good example is factory rental which remains the same irrespective of management wanting to manufacture product A or B.

c. Only CASH flow item And Incremental fixed costs are relevant. Non cash item like depreciation and absorbed fixed overheads are not relevant costs as they do not involve any additional cash flow.