All future costs are relevant in decision making” do you agree?
The statement "All future costs are relevant in decision making" is not universally true. In decision-making, it's essential to distinguish between relevant costs and irrelevant costs.
Relevant costs:-
Relevant costs are those costs that are directly affected by a specific decision, and their consideration can influence the decision's outcome.
Irrelevant costs:-
Irrelevant costs, on the other hand, do not impact the decision and should be disregarded.
Here are some considerations:
Sunk Costs:
Sunk costs are costs that have already been incurred and cannot be changed by future decisions. Sunk costs are generally irrelevant in decision-making because they are not affected by the decision at hand.
Opportunity Costs:
Opportunity costs represent the potential benefit foregone by choosing one alternative over another. Opportunity costs are relevant and should be considered in decision-making as they represent the value of the best alternative forgone.
Incremental Costs:
Incremental costs are the additional costs incurred or avoided as a result of a specific decision. Incremental costs are highly relevant in decision-making, especially when evaluating whether to accept or reject a specific business opportunity.
Avoidable Costs:
Avoidable costs are costs that can be eliminated or avoided by choosing one alternative over another. In decision-making, it's important to focus on avoidable costs that will be affected by the decision.
Fixed and Variable Costs:
Variable costs are usually more directly relevant to short-term decisions, as they vary with the level of activity. Fixed costs that do not change with the decision at hand may be considered irrelevant in certain situations.
Future vs. Historical Costs:
Generally, future costs are more relevant in decision-making than historical costs. Decision-makers are concerned with the impact of a decision on future cash flows and profitability.
Qualitative Factors:
In addition to quantitative factors, qualitative factors such as market conditions, customer satisfaction, and strategic alignment may influence decisions.
In summary, not all future costs are relevant in decision-making. Decision-makers need to focus on relevant costs that will be affected by the decision, including incremental costs, opportunity costs, and avoidable costs. Sunk costs, certain fixed costs, and costs that do not change with the decision may be considered irrelevant. The key is to analyze the specific decision context and identify the costs that will have a direct impact on the decision's outcome.