Benefits for Decision Making
In order to distinguish between the relevant and irrelevant costs, one should understand the way they originate. Relevant costs usually refer to the future expenses that can vary depending on the needs of the business. Relevant costs are relevant to certain managerial decisions, but are irrelevant in other cases. Relevant costs are also interdependent, meaning that if one is chosen, the rest of the options are neglected. Irrelevant costs remain stable despite the changes, initiated by the company management or any other circumstances. Irrelevant costs usually refer to expenses for the past period, or some fixed expenses, which have no effect on the current managerial decision. Sunk costs are the best example of irrelevant costs, since these expenses already took place and cannot be changed.
Opportunity cost determines the economic value of a certain decision in an indirect way, by comparing it to the best available alternative. In other words, it is the value of an opportunity that we miss when we choose its alternative instead. Opportunity cost can be used to evaluate a special order in case an alternative exists, i.e. there is another special offer one might choose to pursue. The value is calculated by means of initial comparison one decision alternative to another. The value of the special order is then expressed in terms of its alternative’s value. Opportunity cost allows to distinguish, which opportunity is better – the actual special order or its alternative.