Relevant cost is a changeable cost that impacts budget decisions. It’s important to analyze current costs to determine which will change and which will remain constant. Understanding relevant costs can help manage expenses and increase profit.
Relevant cost is any type of cost subject to change depending on the type of decision made. Considered a fundamental function in management accounting, the idea behind this type of cost definition is to determine how the budget will be impacted if a certain course of action is followed. To properly assess the situation, it is necessary to analyze all current costs and determine which would change as a result of the decision and which would remain constant. Those who will change are said to be relevant to the consideration of this course of action.
Assessing relevant cost is not a particularly difficult process. All that is needed is to design the chain of events that will occur if a specific action is taken. For example, a restaurant that wants to attract more lunchtime customers might consider implementing a lunchtime special that is only available for a few hours each day. Before actually implementing this new offering, the owner will carefully consider the type of impact the project will have on manpower, supplies and utilities.
If it is determined that the number of serving servers is sufficient to handle the larger lunch crowd, then this cost factor is not relevant as it does not change anything that already occurs. If it is determined that an additional kitchen worker is needed to prepare food during the lunch period, this constitutes a change in labor costs and would be considered a relevant cost. Since more food would likely be needed to manage the additional lunchtime customers, this cost would also be relevant.
The same general principle can be applied to virtually any decision. Investors can analyze what choosing a particular investment scheme would mean in terms of additional expense or demand on their time and determine whether the effort is worth the expected result. Merchants can decide whether adding a specific product to the items they carry is likely to result in an increase in sales volume that will offset the cost of ordering that additional product. Understanding what the decision will change to the normal state of operations always makes it easier to determine whether the decision is beneficial or could have a negative impact.
Understanding the type and nature of a relevant cost can make it easier to use the accounting process to effectively manage expenses, thereby increasing the opportunity to earn a profit. If the amount of relevant cost is so great that the potential for making a profit is greatly diminished, the course of action in question may be determined to be unfeasible and abandoned. From this perspective, a relevant cost or costs were identified in any situation, in addition to increasing the potential for increasing profits, but also preventing the deterioration of the current level of profit.
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