What is an Avoidable Cost?An avoidable cost is a cost that can be eliminated by not engaging in or no longer performing an activity. In general, a variable cost is considered to be an avoidable cost, while a fixed cost is not considered to be an avoidable cost. In the very short term, many costs are considered to be fixed and therefore unavoidable. Over the long term, all costs are avoidable. For example, a 30-year lease is avoidable if the decision-making period is more than 30 years. In the short term, legally-mandated or government-mandated costs, such as leases or environmental cleanup obligations, are not avoidable costs. The avoidable cost concept is crucial when engaging in cost reduction activities. Show
Avoidable Cost AnalysisFrom a risk management perspective, it is useful to periodically review the cost structure of a business and try to shift as many costs as possible from the unavoidable to the avoidable category, which gives management greater room to maneuver if the business suffers a revenue shortfall and must cut back on its expenses. For example, a lease can be renewed with a shorter term, so that management has the option to cancel the related expense within a shorter period of time than had previously been the case. As noted in the example, the general strategic approach to dealing with avoidable costs is to commit to shorter time periods for any planned expenditures. Example of an Avoidable CostIf a company president chooses to close a production line, then the cost of the building in which it is housed is now an avoidable cost, because the company can now sell the building. Similarly, if a rental unit complex is converted over to office space, then the cost of maintaining the pool for renters can now be eliminated. Terms Similar to Avoidable CostAn avoidable cost is also called an escapable cost. Understanding the cost classifications of avoidable and unavoidable costs is vital in order to make a number of business decisions. The key difference between avoidable and unavoidable cost is that avoidable cost is a cost that can be excluded due to stoppage of conducting a business activity whereas unavoidable cost is a cost that continues even if the activity is not performed. CONTENTS What is Avoidable Cost?Avoidable cost is a cost that can be excluded due to stoppage of conducting a business activity. These costs are only incurred if the company decides to proceed with a certain business decision. Further, avoidable costs are direct in nature, i.e. they can be directly traced to the end product. Understanding such costs is advantageous to businesses since it assists in identifying the costs that do not contribute to profits; thus, they can be eliminated by discontinuing the nonprofit making operations. E.g. JKL Company is a large-scale manufacturing company that produces 5 types of consumer products. Each product is completed in a separate production line and marketed and distributed separately. From the results for the past two years, JKL had been experiencing reducing sales from one product due to competitor actions. Thus, the management decided to discontinue the respective product; as such the production, marketing and distribution expenses will be avoided. Variable cost and stepped fixed cost are the main types of avoidable costs. Variable CostVariable cost changes with the level of output, as such is increased when a higher number of units are produced. Direct material cost, direct labor, and variable overheads are the types of variable costs. Thus, if the increase in output is avoided, the related costs will be avoidable. Stepped Fixed CostStepped fixed cost is a form of fixed cost that does not change within specific high and low activity level, but will change when the activity level is increased beyond a certain point. E.g. PQR is a manufacturing company that operates at full capacity and does not have extra production capacity in its factory. The company receives a new order to supply 5,000 units for a customer. Thus, if the company decides to proceed with the above order, HIJ will have to rent out new production premises temporarily for a cost of $ 17,000. What is an Unavoidable Cost?Unavoidable costs are costs a company incurs irrespective of the operational decisions it makes. Unavoidable costs are fixed and indirect in nature, meaning they cannot be easily traceable to the end product. Fixed CostThese are the costs that can be altered based on the number of units produced. Examples of fixed costs include rent, lease rental, interest expense and depreciation expense. E.g. DFE Company produces two different types of products, product A and product B, in the same factory. Factory rent expense is $15,550 per month. Due to a sudden decrease in demand, DFE decided to stop the production for product B. Irrespective of this decision, DFE still has to pay the rent of $15,550. In the very short term, many costs are considered to be unavoidable since they are fixed in nature. For instance, if a customer order is due within two weeks’ time, even the costs such as direct material, direct labor and variable overhead costs for that specific order are unavoidable.  Figure 01: Variable and fixed cost are avoidable and unavoidable in nature What is the difference between Avoidable and Unavoidable Cost?
Summary – Avoidable vs Unavoidable CostThe difference between avoidable and unavoidable cost principally depends on whether they will be increased or decreased based on the level of activity. Certain costs are avoidable while others are unavoidable based on decisions. By identifying and eliminating non value adding processes and discontinuing products that have limited demand assists companies to avoid unnecessary costs and progress towards higher profits. Reference: Image
Courtesy: What are avoidable costs and unavoidable costs and how are they relevant in the decisionA relevant benefit is a benefit that differs between alternatives. An avoidable cost is a cost that can be eliminated, in whole or in part, by choosing one alternative over another. Avoidable costs are relevant costs. Unavoidable costs are irrelevant costs.
What is avoidable cost and unavoidable cost?
What are avoidable costs and why are they important in decisionAvoidable costs are expenses that can be eliminated if a decision is made to alter the course of a project or business. For example, a manufacturer with many product lines can drop one of the lines, thereby taking away associated expenses such as labor and materials.
Are avoidable costs relevant in decisionDifferential, avoidable, and opportunity costs are considered relevant costs. Sunk and fixed overhead costs are irrelevant.
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What are avoidable costs and unavoidable costs and how are they relevant in the decision making process *?
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