It is a type of costing method in accounting where the alternatives are compared and their difference is calculated to consider. Relevant costing technique helps managers to make decisions on certain issues such as whether the components of goods should be bought from vendors or it must be manufactured within in-house plants. It helps in making decisions that whether the business can accept a special order or consignment and what should be charged on that special order. The method of relevant costing uses an incremental approach where it only considers the relevant costs of the two alternatives methods that can be used to produce the similar products. With the help of relevant costing techniques a business may also decides whether to eliminate a certain product line or not.
Relevant costs may also be termed as the future costs that differ between the alternate methods. It is important to consider and calculate relevant costs as a lot of irreverent costs can lead to erroneous decisions in the business. Moreover discarding the irreverent data can also save time and efforts towards the decision making.
For example a business produces motors with a capacity of 1000 units per month with fixed costs of 300,000 and a variable cost of 500 per motor. The business is approached by a company to produce 200 units at 700 per unit. At a glance a layman will reject this order as it seems to be in loss however a accounting manager will accept the order as he knows that fixed costs are irrelevant and they have to incurred in any situation and the order will eventually yield 200 after each unit of motor produced