4RQ - Horngren'S Financial And Managerial Accounting

Question

What are sunk costs? Give an example.

Step-by-Step Solution

Answer

Sunk costs are the costs incurred in the past by the business entities, and they are also considered to be irrelevant to the decision-making process.

Step 1: Meaning of Cost

In accounting, cost refers to the amount of money spent by the business to acquire goods or services. Costs are incurred to generate revenues and flow the money out of business.

Step 2: The meaning of sunk cost and its example

Sunk costs refer to the costs spent by the business in the past, and based on that, future activities are decided, which cannot be changed. Such costs are irrelevant to the business concerns while making a decision. 

For instance, a business bought furniture for $10,000 5 years ago and deals in old furniture. Now the business is planning to buy new furniture. In the given scenario, $10,000 spent in the past is a sunk cost as the business cannot do anything to change that.