What is Irrelevant Cost?
Irrelevant costs are costs which are not useful or rather not at all considered when a company is making a business decision. However, it doesn’t mean that such cost will remain irrelevant for a longer period of time and may become relevant if the business environment or priorities change.
Types of Irrelevant Cost
- Sunk Cost – Sunk costsSunk CostsSunk costs are all costs incurred by the firm in the past with no hope of recovery in the future and are not considered while making any decisions since these costs will not change regardless of the decision's outcome. are the costs for which the company has already spent the cost, and for that, there is no future recovery and Company will not benefit anything in the future from that cost. These costs should not be considered in business decision making as it will adversely affect the cost statement of the company, and future profits can be negatively impacted as well. These costs should be avoided and should not be taken into account for the correct presentation of data.
- Committed Cost – Committed costsCommitted CostsCommitted Costs are fixed, budgeted, or confirmed payments to be made in the future to vendors for goods or services to be taken, which are necessary for the smooth flow of the business and whose absence may disrupt the main operations of the business, potentially having a significant impact on the company. are the costs which are non-erasable from the books of accounts. These costs are committed from the company’s point of view. The entity has already invested for these costs, and proper legal obligation has also been met for which the Company cannot get out of this anymore. Hence these costs are irrecoverable and are fixed in the company’s accounts.
- Notional / Non-Cash Costs – Notional / Non-cash costsNon-cash CostsNon-cash expenses are those expenses recorded in the firm's income statement for the period under consideration; such costs are not paid or dealt with in cash by the firm. It involves expenses such as depreciation. can be coined as the costs which are not directly related to the outflow of cash and company need not have to incur any expense to bear these costs. Still, these costs will automatically take place on a non-cash basis. The company has to forcibly bear these costs as these are unwanted and unavoidable kind of costs.
Examples of Irrelevant Cost
- Rent paid for the Company’s premises
- Money spent on the purchase of new equipment.
- Advertising/Marketing campaign expenses
- Insurance paid by the Company for its employees or the company’s fixed assetsFixed AssetsFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples.
- Different taxes paid by the Company
- Salaries of top-level management who rarely participate in business decision making
- Interest on owner’s capital which the Proprietor brings in to the business but never claims back the interest on his own funds.
- The rent which can be receivable upon using own business premises
- Depreciation is a non-cash item, but it negatively impacts the sale value of the equipment.
- Legal expenses are borne by the Company, which hardly gives any revenue generation.
The importance of irrelevant costs can be explained in different ways because, on the one hand, it is the expense for which business cannot produce any revenues. Hence, these are called irrelevant, but on the other hand, these costs can be irrelevant to one business decision which might not be irrelevant for every business decision. Hence, these costs are important when statement for costs is prepared as at that time; these can be eliminated looking upon the relevancy of the decision making criteria.
Salary to the advertising campaign team is irrelevant when we are making a business decision to buy specialized equipment for the launching of a new product. However, when advertising of that same product comes as a business decision, then the salary of the advertising campaign becomes relevant. Hence the relevancy and importance change from the viewpoint of decision making.
- It helps in identifying the difference between relevant and irrelevant cost.
- These costs clarify the cost already incurred when any new business decision is made and plays a crucial role in maintaining the costing decision of any product/business viable.
This has been a guide to What is Irrelevant Cost and its definition. Here we discuss its top 3 types along with examples, importance, and advantages. You may learn more about financing from the following articles –