Lessons · Accounting · relevant cost, and the cost that is already spent
Relevant cost, and the money already gone
Only costs that change as a result of the decision are relevant to it. A cost already spent is gone whichever way you choose, so it cannot affect which choice is better, however large it is.
Hone is a place to practise a career, one idea a day. This is one of its lessons, written out in full and free to read without an account.
In beta. This lesson was written for Hone and has not yet been checked by a qualified accountant. Practice material, not professional advice. What that means.
What it is for
It is the most counter-intuitive idea in management accounting and the one that saves the most money. The instinct to justify what has already been spent, by spending more, is strong enough to have its own name, and it has sunk companies. The arithmetic is the only reliable defence against it.
How to think about it
List what you would spend under each option from this moment on. Cross out anything that appears identically in both, and anything already paid. Compare what is left.
Worked example
Spent 40,000 developing a product so farSunk. It is gone under every option including abandonment.
Finish it: 15,000 more, revenue 22,000Better off by 7,000 from here.
Abandon it: nothing more, nothing backBetter off by nothing from here.
Finish. The 40,000 does not enter the comparison at allAnd it would have argued for finishing a product that could not pay for the rest of its own development.
Your turn
Name the kind of cost that is already spent and cannot change the decision.
A cost already spent is a cost and is never relevant
Solve one, graded on the server
The trap
Including a share of general overhead that will be incurred anyway. If head office costs the same whatever you decide, it is identical under both options and belongs in neither column.