Relevant costs for decisions

A relevant cost is a future cash flow that changes because of the decision being made. Sunk costs, committed costs, depreciation and reallocated overheads are not relevant, while opportunity costs, such as a sale given up or contribution lost on displaced work, are. For one off decisions like a special quote, a shutdown or using spare stock, only the relevant figures should be compared.

What makes a cost relevant?

ACCA’s technical article on relevant costs defines a relevant cost as any cost relevant to a decision, and treats an item as relevant if the decision causes a change in cash flow. That change can be an extra payment, a reduced payment, extra revenue or lost revenue. The article’s practical test is to ask whether the amounts on the business’s bank statement would be different because of the decision.

Three conditions follow from that definition. A relevant cost is future, because past spending cannot be changed. It is a cash flow, because accounting entries such as depreciation do not move money. And it is incremental: it differs between the options being compared. A cost that is the same whichever option is chosen can be left out.

Which costs are not relevant?

• Sunk costs. ACCA describes these as money already spent or already contracted to be spent, such as market research on a new product or planning work for a new factory. It will not come back whatever is decided.
• Committed costs. Future costs that cannot be avoided because of an earlier decision. ACCA’s example is a two year machine lease, which is not relevant to whether that machine is used on a one month project.
• Reapportioned fixed costs. However the management accounts split overheads, if the total does not change there is no cash effect. ACCA stresses that additional fixed costs caused by a decision, such as rent on a building leased specially, are relevant.
• Depreciation and book values. ACCA calls these notional costs: depreciation is not a cash flow and book value is simply historical cost less depreciation.

What is an opportunity cost and how do you value it?

ACCA defines an opportunity cost as the value of a benefit forgone when one course of action is chosen in preference to another. If a business keeps an asset to use on a new product instead of selling it, the lost sale proceeds are a relevant cost of the new product. If skilled staff are moved from existing work, the contribution that work would have earned is lost. Opportunity costs never appear in the ledger, which is why they are the costs most often missed.

How do you value materials?

ACCA’s materials example sets out three cases, which together form the standard rules:

In ACCA’s example, 100 units of a material bought at $10 with no other use could be sold for $12, so their relevant cost is the $12 sale value given up, and the extra 50 units needed are valued at the current $14 purchase price. Material in regular use, bought at $20 and now costing $22, is valued at $22 throughout.

How do you value labour?

• Spare capacity already paid for. If staff are paid anyway and have idle time, using that time costs nothing extra.
• Extra hours or new staff. Overtime, temporary staff or new hires are relevant at their full cost.
• Staff diverted from other work. ACCA explains that the relevant cost is the labour cost plus the contribution forgone on the work given up. Using only the lost contribution understates the cost, because that contribution is already stated after the labour cost. In ACCA’s example skilled labour paid $15 an hour is diverted from a product earning $6 of contribution per labour hour, so each hour is valued at $21.

What does a full worked example look like?

Illustration only. A printing business is asked to quote for a one off job and wants the lowest price that would leave it no worse off.

£806 is the floor. A quote above it adds to profit; one below it makes the business worse off. Whether to price well above the floor is a commercial judgement covered in pricing methods. The costing system’s figure for the same job would include depreciation, absorbed overhead and the historic card cost, giving a very different answer.

How do the rules apply to shutdown and further processing decisions?

Closing a loss making line. In ACCA’s example, two production lines share $24m of fixed costs apportioned by floor space. Line B shows a $4m loss, but it earns $10m of contribution, and closing either line would save only 25% of the fixed costs, $6m. Closing B would lose $10m to save $6m. The apparent loss comes from apportionment, which is why a contribution presentation is better for decisions; see contribution margin.

Processing further. ACCA’s joint product example shows that the cost of the shared input is irrelevant to whether each output should be processed further. The test is whether the extra revenue from processing exceeds the extra processing cost: in the example, processing component B adds $11,000 of revenue for $8,000 of cost and is worthwhile, while component A adds $5,000 for $6,000 and is not.

Keep or sell an asset. ACCA’s machinery example values an old machine at the $75,000 it could be sold for now, not its $50,000 book value or the $300,000 it originally cost. Updating it for $100,000 to earn $150,000 of contribution leaves a net $25,000 worse off than selling. The same reasoning drives make or buy decisions.

How does tax fit in?

Tax is a cash flow, so where a decision changes the tax bill the change is relevant. For companies, GOV.UK gives the Corporation Tax main rate as 25% on profits over £250,000 and the small profits rate as 19% on profits of £50,000 or less, with marginal relief in between, so the tax effect of a decision depends on which band the extra profit falls into. Although depreciation is ignored, capital allowances are tax relief that, as GOV.UK puts it, let a business deduct some or all of the value of an item from its profits before tax; GOV.UK lists the annual investment allowance of up to £1 million among them. The tax saving from allowances on new equipment is therefore a relevant inflow, and its timing can affect the decision; see capital allowances explained. For small, short decisions tax is often left out because it scales both options equally.

What mistakes come up most often?

• Valuing stock at what was paid for it instead of its replacement price or disposal value.
• Treating the wages of staff who are paid anyway as an extra cost, or forgetting the contribution lost when they are diverted.
• Including absorbed overheads or depreciation from the costing system.
• Letting money already spent on research or samples influence whether to carry on.
• Leaving out avoidable fixed costs, such as a lease or licence taken out only for the project.
• Using relevant cost prices for regular work: the floor price covers only the extra cash, so all work priced this way would leave fixed costs unpaid. The link with absorption and marginal costing explains why the two figures differ.

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Sources

• ACCA: Relevant costs
• GOV.UK: Corporation tax rates
• GOV.UK: Capital allowances

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.