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Relevant cost is any type of cost that is subject to change, depending on what kind of decision is made. Considered a key function within management accounting, the idea behind this type of cost definition is to determine how the budget will be impacted if a particular course of action is pursued. In order to properly evaluate the situation, it is necessary to look at all current costs, and determine which ones would change as a result of the decision, and which ones would remain constant. Those that will change are said to be relevant to the consideration of that course of action.
Assessing the relevant cost is not a particularly difficult process. All that is required is to project the chain of events that will take place should a particular action be taken. For example, a restaurant that wishes to attract more customers for lunchtime may consider implementing a lunchtime special that is only available for a few hours each day. Before actually implementing this new offering, the owner will look closely at what type of impact the project will have on labor, supplies, and utilities.
If it is determined that the number of servers on duty is sufficient to handle the larger lunch crowd, that cost factor is not relevant, as it changes nothing from what already takes place. Should it be determined that an additional laborer in the kitchen is needed to prepare food during the lunchtime period, this does constitute a change in labor costs and would be considered a relevant cost. Since more food would likely be required to manage the additional lunchtime customers, that cost would also be relevant.
The same general principal can be applied to just about any decision. Investors may look at what choosing a given investment scheme would mean in terms of additional expense or demand of their time, and determine if the effort is worth the expected outcome. Shopkeepers can decide if adding a specific product to the items they carry is likely to result in an increase of sales volume that will offset the cost of ordering that additional product. Understanding what the decision will change as far as the normal state of operations always makes it easier to determine if the decision is ultimately beneficial, or likely to have a negative impact.
Understanding the type and nature of a relevant cost can make it much easier to use the accounting process to effectively manage expense, thus increasing the opportunity for earning a profit. Should the amount of relevant cost be so great that the potential for earning profit is greatly diminished, it may be determined that the course of action under consideration is not viable, and is abandoned. From this perspective, identified a relevant cost or costs in any given situation not only enhances the potential for increasing profits, but also prevents the deterioration of the current level of profit.
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