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What Is an Irrelevant Cost?

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  • Written By: Kenneth W. Michael Wills
  • Edited By: Kaci Lane Hindman
  • Last Modified Date: 19 September 2014
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Managerial accounting assigns the term irrelevant cost to represent a business cost that does not impact a management decision. This cost can be positive or negative and may include overhead costs, book values, sunk costs, notional costs, non-monetary costs or fixed expenses. It is important to note, however, that an irrelevant cost is not always irrelevant depending on the situation. In one decision a specified cost may be irrelevant to that decision, but with another managerial decision that cost may indeed be relevant, thus the term relevant cost, which is decision specific. Since an irrelevant cost does not impact a managerial decision, in all likelihood the cost will not change that decision.

An example would be the salary of a marketing director. If executive management decides to restructure the marketing department in order to cut costs and eliminate wastage, the salary of the marketing director is a relevant cost in this decision. Considering the marketing director’s salary and how that sum impacts cash flow in the marketing department will likely be part of such a strategic decision, especially if the company decides to outsource the function. On the other hand, if executive management is looking at adding a manufacturing arm to its business, the marketing director’s salary has no impact on such a decision and is therefore an irrelevant cost.

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When categorizing costs, many non-cash items are often considered irrelevant in relation to most business decisions. Such non-cash items may consist of depreciation, amortization or any other item that does not impact cash flow. Cash flow in these cases accounts for both cash going out as well as coming into the company. Regardless of the fact, however, impact on cash flow is not the only indicator of whether a cost is irrelevant, nor is it the only quantifier.

Money terms, as such, is not the only indicator of an irrelevant cost in the managerial decision making process. Any situation that involves either a positive or a negative will incur some form of cost, despite how that cost is accrued. Important in terms of managerial decisions are whether the associated positive or negative has an impact on decisions made. For example, lost production can be quantified in a number of ways aside from lost profits. Quantifying loss of production many instead indicate to a slower time to market for a new product, and this may be far more important to some types of strategic decisions than lost profits.

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burcinc
Post 3

Often times, people make the mistake of considering sunk costs, or costs that have already been paid, when making decisions. But sunk costs are irrelevant because there is no way that the cost can be recovered.

My economics teacher says that it is easier to think of irrelevant costs as unavoidable costs. Any cost that is unavoidable is irrelevant to whatever decision that is being taken. This is how I remember the difference between irrelevant and relevant costs.

We have to concentrate on what's relevant or avoidable. If there is a cost that has already been paid out or if there is going to be a cost in the future that cannot be avoided for whatever reason, it is irrelevant.

donasmrs
Post 2

@SarahGen-- Because if a business doesn't make the distinction between irrelevant and relevant costs in regards to a decision, their decision might be wrong.

Plus, it will take them longer to come to a decision if they are spending their time considering irrelevant costs.

SarahGen
Post 1

Why is it important for a business to determine which costs are irrelevant?

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