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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.
Frequently Asked Questions
How is 'sunk cost' related to 'variable cost'?
A variable cost is a type of cost that fluctuates as volume changes. Sunk costs are costs that have already been incurred and cannot be avoided or changed. So, sunk costs are not relevant in decision-making situations; they will not change depending on the decision made (they are already completed). Variable costs are only relevant in the decision-making process since they change depending on the decision made.
What is 'sunk cost'?
Sunk costs are a type of cost that has already been incurred and cannot be avoided or changed. So, sunk costs are irrelevant to current decision-making.
How do I calculate a sunk cost?
To calculate a sunk cost, you simply subtract the amount of money you've spent from the total amount of money you had available to spend.
What are some examples of sunk costs?
Some examples of sunk costs include: movie tickets, non-refundable plane tickets, and investments that have gone bad.
Are sunk costs always bad?
Sunk costs are not always bad, but they should not be the sole determinant of your decisions.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.
To learn more about True, visit his personal website, view his author profile on Amazon, his interview on CBS, or check out his speaker profile on the CFA Institute website.
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