Classification of costs for decision making
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Classification of costs for decision making
Classification by relevant and irrelevant costs
Relevant costs – future costs which will be changed by a decision.
Irrelevant costs – costs which will not be affected by a decision.
Sunk costs
Costs that have been created by a decision in the past and which cannot be changed by any decision that will be made in the future.
Sunk costs are irrelevant for decision-making.
Opportunity costs
A cost which measures the opportunity which is lost or sacrificed when the choice of one course of action requires that an alternative course of action be given up.
Classification by cost behaviour
Enables cost to be estimated at different output levels. Such information is important for decision-making.
Variable costs vary in direct proportion with the level of activity.
Total variable costs are linear and unit variable cost is constant.
Fixed costs remain constant over a wide range of activity for a specified period.
Total fixed costs are constant across all levels of activity whereas unit fixed costs decrease proportionally with the level of activity.
Semi-variable costs include fixed and variable component.
Semi-fixed/step costs are fixed for a given level of activity but eventually increase by a constant amount at some critical point.
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