BAR Relevant Costs: What Numbers Actually Matter?
Relevant-cost questions often look difficult because they give you too much information. Your job is to identify which future cash flows change because of the decision.
The basic rule
A cost is relevant when it is future and different between alternatives. If the cost happens either way, it generally does not help choose between the alternatives.
Sunk costs
A sunk cost already happened and cannot be changed. It may matter emotionally, but it does not change the future economic choice.
Avoidable fixed costs
A fixed cost is not automatically irrelevant. Ask whether it disappears if the alternative is chosen. If yes, it may be relevant. If the company merely reallocates the same fixed overhead, it may not be relevant.
Opportunity costs
Opportunity cost may not appear in the accounting records, but it can still be relevant. If using factory space for Product A means giving up contribution margin from Product B, that lost benefit matters.
Make or buy
Compare costs avoided by not producing internally, plus opportunity costs if any, against the cost of purchasing externally. Do not automatically include allocated fixed overhead.
Special orders
Ask whether there is idle capacity, whether the order affects normal sales, what incremental revenue is earned, what incremental costs occur, and whether opportunity costs exist.
Keep or drop a segment
Do not eliminate a segment simply because it reports an accounting loss. Determine which revenues disappear and which costs actually disappear.
The takeaway
Relevant cost analysis is a future cash-flow comparison, not a full income statement.
Related Summit guides
FAQ
Are fixed costs irrelevant?
Not automatically. Avoidable fixed costs can be relevant.
Are sunk costs ever relevant?
They generally should not affect a future decision because they cannot be changed.
Do opportunity costs count if they are not recorded?
Yes, when the alternative causes the company to give up another economic benefit.