What are sunk costs?

Definition

Sunk cost is the term used for a cost that has already been incurred and now cannot be avoided or changed and consequently it is irrelevant for the current decision-making situation.

Explanation

Sunk costs are those costs that have already been incurred. Sunk costs cannot be changed by a decision and hence they are irrelevant in the decision-making process. The important point here is that if sunk costs are included in the decision-making process, it will make it difficult for management to focus on important decision variables.

Example

For example, a company has bought a building for its showroom at a cost of $5,00,000. The company is considering a change in its product mix. Cost of the building and its depreciation will be the same whatever may be the composition of the company’s product mix. So this cost being unavoidable has no relevance to the current decision-making situation and is referred to as sunk cost.

Also Check:  Semi-variable costs

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