Cost Saving Secrets Of Relevant Costing: Know Everything About It
Relevant Costing: Meaning, Examples and Techniques Explained
Relevant costing is a way of making business decisions by looking only at the costs and revenues that change because of that decision. It ignores sunk costs and unavoidable fixed costs. This guide is for CA Inter, CA Final and commerce students who want clear, simple examples. The key takeaway: if a cost stays the same whichever option you pick, leave it out, and compare only the future cash that differs.
Key takeaways
- Relevant costs are future costs that differ between your options.
- Sunk costs and historical costs never matter for the decision.
- Fixed costs are irrelevant only if they’re unavoidable. Avoidable fixed costs count.
- Opportunity costs are relevant, even though no cash leaves your pocket.
- It powers make-or-buy, special order and shutdown decisions.
- It looks at numbers only, so weigh quality, people and strategy too.
What is relevant costing?
Relevant costing is a managerial accounting technique. You use it to decide between alternatives by looking at just the costs and revenues that change with your choice. Everything else is noise.
Think of it as a filter. You start with every number you can find. Then you throw out whatever stays the same no matter what you decide. What’s left is what actually drives the decision.
It’s used across finance, marketing, production and operations management. And if you’re preparing for CA Inter Cost and Management Accounting, it’s one of the most useful chapters you’ll learn. For a formal definition, see AccountingTools or the Wikipedia entry on relevant cost.
Relevant costs vs irrelevant costs
Every cost in a decision falls into one of two buckets. Here’s the quick split.
Relevant costs
Future costs that change with the decision.
- Variable costs
- Opportunity costs
- Incremental costs
- Avoidable fixed costs
Irrelevant costs
Costs that stay the same whatever you choose.
- Sunk costs (already spent)
- Historical costs
- Unavoidable fixed costs
- Allocated overheads that won’t change
| Cost type | Relevant? | Why |
|---|---|---|
| Raw material for a new order | Yes | You’ll spend it only if you accept the order. |
| Machine bought last year | No | It’s a sunk cost. You can’t get it back. |
| Rent that stops if you close a unit | Yes | It’s avoidable, so it changes with the decision. |
| Head-office rent that continues anyway | No | It’s the same under every option. |
| Profit you give up by using a machine for one job | Yes | That’s the opportunity cost. |
How relevant costing works
You can run almost any decision through the same six steps.
Relevant costing techniques
Differential analysis
This is the main tool. You list the relevant costs and revenues for each alternative, then compare them. The cheapest or most profitable option wins.
Marginal costing
Marginal costing separates fixed and variable costs. It then works out the contribution margin per unit, which is selling price minus variable cost. It’s handy when you’re deciding whether extra units are worth making.
Activity-based costing (ABC)
ABC assigns indirect costs to products based on the activities that cause them. It isn’t a relevant costing method by itself. But it helps you spot which overheads really change with a decision. Read more on activity-based costing.
Where you’ll use relevant costing
Make or buy
Should you produce a part in-house or outsource it? Compare the avoidable cost of making with the vendor’s price.
Special order
Should you accept a one-off order at a lower price? If it covers its extra costs and your capacity is idle, it can add profit.
Shutdown
Should you stop a product or unit? Compare the revenue you’d lose with the costs you’d truly avoid.
A real-life example: last-minute train seats
Picture a train with a few empty seats just before departure. Once it leaves, those seats earn nothing. Carrying one more passenger adds almost no cost. So the relevant cost of filling a seat is tiny, and even a discounted fare adds revenue. Last-minute seat sales follow exactly this logic.
A worked make-or-buy example
A company needs 1,000 units of a component. Making it costs the figures below per unit. A vendor offers it at ₹90 per unit.
| Item (per unit) | Make (₹) | Buy (₹) | Relevant? |
|---|---|---|---|
| Direct material | 40 | – | Yes |
| Direct labour | 30 | – | Yes |
| Variable overhead | 10 | – | Yes |
| Allocated fixed overhead (unavoidable) | 20 | – | No |
| Vendor price | – | 90 | Yes |
| Relevant cost per unit | 80 | 90 | Make it |
The ₹20 fixed overhead is there whether you make or buy, so you ignore it. Making saves ₹10 per unit, or ₹10,000 on 1,000 units. If you could rent out the spare capacity for more than ₹10,000, that opportunity cost would flip the answer.
Prefer to watch it explained? Watch Parag Sir’s video on YouTube.
Limitations of relevant costing
It’s powerful, but it isn’t perfect.
- It assumes everything else stays constant. In real life, prices, demand and capacity keep moving.
- It focuses on numbers. Quality, brand, staff morale and supplier reliability matter too.
- It needs good estimates. Future costs are forecasts, and wrong forecasts give wrong answers.
So use it as a strong starting point, then add your own judgment on the non-financial side.
Relevant costing FAQs
What is relevant costing?
Relevant costing is a managerial accounting technique that picks out the costs and revenues that change because of a specific decision. You compare only those figures across your options. Businesses use it in finance, marketing, production and operations to decide with confidence.
What are some examples of relevant costs?
Relevant costs are future costs that differ between options. Variable costs, opportunity costs, incremental costs and avoidable fixed costs are the usual examples. If a cost changes because of your choice, it belongs in the analysis.
What is the difference between relevant and irrelevant costs?
Relevant costs are future costs that change with the decision. Irrelevant costs stay the same whatever you choose. Sunk costs, historical costs and unavoidable fixed costs are the classic irrelevant ones.
What techniques are used in relevant costing?
Differential analysis, marginal costing and activity-based costing (ABC) are the common ones. Differential analysis compares alternatives. Marginal costing looks at variable costs and contribution. ABC assigns indirect costs by activity.
What are common applications of relevant costing?
Make-or-buy decisions, special order decisions and shutdown decisions are the big three. Make-or-buy asks whether to produce in-house or outsource. Special orders ask whether to accept a one-off order. Shutdown decisions ask whether to stop a product or unit.
How does relevant costing work?
List your options, then write down the future cash costs and revenues for each. Strike out anything that’s identical across options, like sunk costs and unavoidable fixed costs. Compare what’s left. The option with the better net result wins.
Is relevant costing worth learning?
Yes. It’s a high-scoring topic in CA Inter Cost and Management Accounting and returns in CA Final SCPM. It’s also practical. Managers use the same logic when they decide whether to outsource, accept a discount order or close a loss-making unit.
Who is relevant costing best for?
It suits CA, CMA and commerce students preparing for exams, and managers or business owners who face either-or decisions. If you ever ask “should we make it, buy it or drop it?”, relevant costing gives you a clean way to answer.
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CA Parag Gupta has taught CA Inter and CA Final for over two decades and founded StudyByTech. Learn relevant costing the simple way, with lots of exam-style practice.
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About the author. CA Parag Gupta is a Chartered Accountant, former CA Final examiner and ICAI observer. His students include many rank holders.
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