Question

What do we mean by sunk costs? Where do we see this concept applied most often?

Answer 1

The sunk cost refers to the cost which is already incurred before proceeding to accept a project or not.

It is considered to be an irrelevant cost in decision making of an investment since it is a cost which is incurred before starting a particular project and hence has no relevance in deciding as to whether a project shall be executed or not.

For example: A firm incurred $ 10,000 in research and development cost before initiating a project and this cost is non recoverable. Now this cost of $ 10,000 is incurred and can not be recovered and hence does not have relevance either if we we initiate the project or not. Thus, sunk cost is a kind of irrelevant cost.

The concept is mostly seen to be applied in relevant costing.

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