In accounting, what is meant by relevant costs?

Definition of Relevant Costs

Relevant costs are future costs that will differ between two or more alternative actions. Expressed another way, relevant costs are the costs that will make a difference when making a decision.

Past costs may help you predict and estimate the future costs, but the past costs are otherwise irrelevant to the decision. That is why accountants will refer to a past cost as a sunk cost.

Examples of Relevant Costs

Assume that a company has five product lines: A, B, C, D, and E. Since E accounts for only 5% of the company's sales, the company is deciding whether to eliminate E. If E is eliminated, the compensation of E's employees and other expenses directly associated with E (amounting to $400,000) will be eliminated. However, the company's other expenses (executives' compensation, depreciation, general administration) will not be reduced.

The $400,000 of costs that are directly associated with E are relevant costs, since the company will see its total costs decrease by $400,000 when E is eliminated. Since the company's other expenses will not change, the company's other expenses are not relevant. In other words, it doesn't matter for the decision to eliminate product line E whether the company's other expenses are $500,000 or $5,000,000.