Direct cost as a relevant cost
Direct costs may be directly chargeable to a product or a cost center. They may be fixed costs or variable costs when it comes to decision-making.
Incremental costs as relevant costs
An incremental cost is specifically incurred by the following a course of action and avoidable if such action is not implemented. This contrasts with sunk costs, which have already been incurred and cannot be avoided whether the future course of action is taken. Incremental costs are relevant in decision-making situations such as
- Whether to buy in a component or service or manufacture it using the company’s own resources
- Whether to further process one of the joint products which emerge from a process before it is sold or sell it in its existing form without further processing
Opportunity costs are relevant costs:
Opportunity cost introduces an additional concept which is not available as part of normal cost analysis in the accounting record system
Opportunity cost may be defined as ‘the best opportunity foregone by following a particular course of action’ it may be redefined as the net cash flow lost by choosing one alternative rather than another.
Opportunity cost may be used in a number of decision making situations where there is an alternative choice between possible future course of action examples are:
- Whether to close a department immediately or in one years time
- Whether to operate an internal service department or to use an outside service
- Whether to accept one or another of two mutually exclusive contracts
Opportunity costs will be part of an incremental cost and revenue analysis in many decision making situations