engineering

Relevant cost

Relevant cost is a engineering topic covered in the lgStudy science library. This page brings together a partial reference excerpt, illustrations, worked examples, real-world applications and a short study plan, so you can understand Relevant cost rather than just read about it. In short: A relevant cost (also called avoidable cost or differential cost) is a cost that differs between alternatives being considered. In order for a cost to be a relevant cost it must be: Future Cash Flow Incremental It is often important for businesses to distinguish between relevant and irrelevant costs when analyzing alternatives because erroneously considering irrelevant costs can lead to unsound business decisions.

Key takeaways

Relevant cost belongs to engineering; place it in that map before memorising details.
Learn the definition first, then one example that makes the definition concrete.
Connect Relevant cost to a quantity you can measure, compute or draw — that is where exam questions come from.
Reproduce the core statement of Relevant cost from memory before moving on to harder problems.

Reference excerpt

A relevant cost (also called avoidable cost or differential cost) is a cost that differs between alternatives being considered. In order for a cost to be a relevant cost it must be:

Future Cash Flow Incremental It is often important for businesses to distinguish between relevant and irrelevant costs when analyzing alternatives because erroneously considering irrelevant costs can lead to unsound business decisions. Also, ignoring irrelevant data in analysis can save time and effort. Types of irrelevant costs are:

Sunk costs Committed costs Notional or Non cash costs (e.g depreciation and amortization)

Example A construction firm is in the middle of constructing an office building, having spent $1 million on it so far. It requires an additional $0.5 million to complete construction. Because of a downturn in the real estate market, the finished building will not fetch its original intended price, and is expected to sell for only $1.2 million. If, in deciding whether or not to continue construction, the $1 million sunk cost were incorrectly included in the analysis, the firm may conclude that it should abandon the project because it would be spending $1.5 million for a return of $1.2 million. However, the $1 million is an irrelevant cost, and should be excluded. Continuing the construction actually involves spending $0.5 million for a return of $1.2 million, which makes it the correct course of action. A managerial accounting term for costs that are specific to management's decisions. The concept of relevant costs eliminates unnecessary data that could complicate the decision-making process.

References

Worked examples

Example 1 — a first encounter with Relevant cost

Start with the simplest possible case. Write down what Relevant cost claims or describes in one sentence, then invent the smallest concrete situation in which that sentence is true. In engineering, the smallest case is usually a single object, a single equation or a single measurement. Check that every symbol or term in your sentence has a meaning in that case.

Example 2 — changing one variable

Take the situation from Example 1 and change exactly one quantity: double it, halve it, or set it to zero. Predict what should happen to Relevant cost before you calculate. Comparing your prediction with the result is the fastest way to find out whether you understand the idea or only the words.

Example 3 — an exam-style question

Typical questions about Relevant cost ask you to (a) state it precisely, (b) apply it to given data, and (c) explain a limitation. Practise writing all three answers in under five minutes; the third part is what separates a full-mark answer from an average one.

Applications of Relevant cost

In research: Relevant cost appears in engineering research whenever the underlying quantities have to be modelled precisely. Papers usually cite it as a starting assumption and then explore where it breaks down.
In technology and industry: Engineering practice reuses Relevant cost in design rules, simulations and safety margins. Knowing the idea lets you read a specification sheet and understand why the numbers look the way they do.
In the classroom: Relevant cost is common in secondary-school and first-year university syllabi. It links to neighbouring topics Cost engineering, Costs, Management accounting, so understanding it makes those chapters shorter.
In everyday life: Look for Relevant cost outside the textbook — in sport, cooking, traffic, electronics or the sky above you. An example you found yourself is remembered far longer than one you were given.

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How to study Relevant cost in 20 minutes

Read the reference excerpt below once, without taking notes.
Close the page and write down what Relevant cost means in your own words.
Compare your version with the excerpt and mark what you missed.
Work through the three examples above with pen and paper.
Explain Relevant cost out loud to somebody else — or to Teacher Smith in the lgStudy chat.

Frequently asked questions

What is Relevant cost in simple terms?

A relevant cost (also called avoidable cost or differential cost) is a cost that differs between alternatives being considered. In order for a cost to be a relevant cost it must be: Future Cash Flow Incremental It is often important for businesses to distinguish between relevant and irrelevant cost…

Why does Relevant cost matter?

Because it connects several engineering ideas at once: it gives you a definition you can apply, a quantity you can calculate, and a way to check whether a result is plausible.

How should I study Relevant cost?

Read the excerpt, restate it from memory, then work through the examples and applications listed on this page. The five-step study plan above takes about twenty minutes.

What does this page cover?

It gives you a compact reference excerpt plus original lgStudy explanations, examples, applications and study material on Relevant cost.