Relevant Cost and Features of relevant Cost

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Relevant cost : Costs which are relevant for a particular business option, which are not historical cost but future costs to be associated with different inputs and activities related a business process. Actual, current or historical costs may be used for estimating the future costs of each alternative choice.

Relevant cost in decision making process : In business operation, there may be alternative choices of doing things. The management accountant has a great role in the dicision making process of which one out of the alternatives is most profitable, keeping in mind of its technical feasibility. In the planning process of future business operation, these decisions are taken into consideration.

The contribution approach, coupled with the ability to distinguish between relevant and irrelevant costs will prove to be a boon for the managers in arriving at correct conclusions in the challenging area of decision making.

Following two conditions need to be satisfied for a cost to be called a relevant cost:-

1. Occur in the Future - every decision deals with selecting a course of action based on its expected future results

2. Differ among the alternative courses of action - costs and revenues that do not differ will not matter and will have no bearing on the decision being made.

For example, while considering a proposal for plant replacement by discarding the existing plant, the original cost and the present depreciated book value of the old plant are irrelevant as they have no impact on the decision for replacement just going to be taken place. However the expected sales value of the discarded plant is relevant, as it just goes to reduce the amount of investment to be made in the new plant and so it has an influence on the decision. 

Moreover, outcome of the investment is also taken into consideration for decision making. Relevant cost analysis helps in drawing the attention of managers to those elements of cost which are relevant for the decision.

The following examples pin-point those costs which are not relevant to a decision at hand.

These irrelevant costs do not play any role in the decision making:
(i) Historical or sunk costs are irrelevant as they do not play any role in the decision
making process. But they are the best basis for predicting future costs. For example, if old and obsolete spare parts worth $5,00,000 are to be scrapped and sold for $15,000, the original cost of $5,00,000 is irrelevant to the decision.
(ii) Even among future costs, those variable costs which will not differ under various alternatives are irrelevant. For example, a company proposes to re-arrange plant facilities and estimates its future costs under two alternative choices, as under:

(iii) If fixed expenses remains unchanged under different alternatives such expenses are irrelevant to the decision at hand.

(iv) Quite often question arises whether the book value of an equipment is relevant or not. Three points as described below emerge in such circumstances:
(a) Book value of old equipment is irrelevant because it is a past cost.
(b) The disposal value of an equipment is relevant because it adds to the cash inflow arising from the decision.
(c) Cost of new equipment is relevant because cash outflow arises by the decision to buy the new equipment.
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