Definition

Sunk cost is a cost that has already been incurred and cannot be avoided or changed. Consequently, sunk costs are irrelevant to current decision-making.

Explanation

Sunk costs have already been incurred. No matter the decision, a sunk cost cannot be changed. Hence, these costs are irrelevant in the decision-making process.

Importantly, if sunk costs are included in the decision-making process, this makes it difficult for management to focus on the key decision variables.

Example

Suppose that Sample Limited purchased a building for its showroom at a cost of $500,000 in 2020.

The company is now considering a change to its product mix.

The cost of the building and its depreciation will be the same regardless of the composition of the company’s product mix. So, this cost—being unavoidable—has no relevance to the current decision-making situation and is a sunk cost.

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