What are sunk costs and why are they not relevant in making decisions?
Costs incurred in the past for the acquisition of an asset [or a resource] are called sunk costs. They cannot be changed, no matter what future course of action is taken because past expenditures are not recoverable, regardless of current circumstances. After an asset or resource is acquired, managers may find that it is no longer adequate for the intended purposes, does not perform to expectations, is technologically out of date, or is no longer marketable. A decision, typically involving two alternatives, must then be made: keep or dispose of the old asset. In making this decision, a current or future selling price may be obtained for the old asset, but such a price is the result of current or future conditions and does not “recoup” a historical cost. The historical cost is not relevant to the decision. These decisions provide an excellent introduction to the concept of relevant information. The following illustration makes some simplistic assumptions regarding asset acquisitions, bu
