And Their Application to Incremental Cost Analysis
Alan Pizzey (1989) defines cost as, “A measure of the resources used up to achieve a certain aim, and can be expressed as so much per unit of production or as the cost of operation of a section of the business”. Incremental Cost Analysis is a financial methodology used to evaluate the impact of changes in revenues on a particular potential scenario. The various categories of cost discussed in the paper are; Sunk Costs, Relevant costs, irrelevant costs, Fixed Costs/Variable Costs, Cost of goods sold, Opportunity cost.
Sunk Costs: Are costs which the organization had previously incurred in the past and cannot be regained.
Relevant Costs: These are also termed as avoidable or differential costs. They refer to the costs that are specific to a management’s decisions.
Irrelevant costs: Are costs that do not play an immediate and direct significant role in a present managerial decision, though they may be necessary in other instances.
Fixed and variable costs: Fixed costs do not change regardless of the prevailing conditions while variable costs keep on fluctuating depending on the prevailing conditions of production.
Cost of goods sold: Are direct costs involved in the production of the goods or services offered by a company.
Opportunity Cost: Is the value of the best foregone alternative relating to the cost that one is giving up by using their resources in favor of one option over another.
Sunk costs and cost of goods sold are utilized in incremental cost analysis. Sunk costs ensure that future value of goods cannot be evaluated on the past values. Replacement of a company’s vehicles will involves considering of the sunk costs and market aspects.
Among the six, sunk costs and cost of goods sold are heavily utilized in incremental cost analysis. Sunk costs involve costs incurred in the past and hence no future decisions can be undertaken to reverse the situation. While on the other hand, the cost of goods influences the decisions made by the management which involve the Incremental Cost Analysis.
Consider a business enterprise that is considering replacement of its old automobile, using incremental analysis, the business would not reflect on the cost of the existing automobile as it is a sunk cost implying that the cost of purchasing it cannot be reversed. The management would consider aspects such as the current market price of the vehicles, the fuel cost incurred by each vehicle and mo significantly, the amount of time that will be saved by having the workers use a more efficient mode of movement.
References
Cost & Management Accounting, Alan Pizzey (1989). An introduction for students 3rd Edition.
