A note on avoidable and unavoidable fixed costs in relevant cost analysis

A note on avoidable and unavoidable fixed costs in relevant cost analysis

 

Regarding the topic of relevant cost analysis in advanced management accounting, some fixed costs are avoidable and some fixed costs are not avoidable. Could you provide 2 examples on each of these 2 types of fixed costs?

 

Yes. In relevant-cost analysis, a fixed cost is avoidable if it disappears (fully or partly) when a particular alternative is chosen; it is unavoidable if it continues regardless of the decision. Avoidable fixed costs are relevant; unavoidable fixed costs are not.

Avoidable fixed costs

These are fixed costs traceable to a product, department, or activity that management can eliminate by discontinuing or changing that activity.

Example	Why it is avoidable
Salary of a supervisor employed solely for a product line	If the company stops producing that product line, the supervisor is no longer needed, so the salary is saved.
Rent for a separate warehouse used only by one division	If the division is closed and the lease can be terminated, the rent is eliminated.

Unavoidable fixed costs

These costs continue even after the activity, department, or product is discontinued; they are often shared “common” costs or arise from binding commitments.

Example	Why it is unavoidable
Example	Why it is unavoidable
Depreciation on factory equipment already owned	The equipment has already been purchased; depreciation is a sunk, non-cash cost that continues regardless of whether a particular product is made.
Company-wide head-office rent allocated to a department	Closing one department does not remove the overall head-office rent; the cost is merely reallocated among the remaining departments.

Decision rule

For a make-or-buy, drop-a-product, or close-a-department decision, include only the fixed costs that would actually be saved under the chosen alternative. For example, if closing a product line saves a $20,000 supervisor salary but leaves $50,000 of allocated head-office rent unchanged, only the $20,000 is relevant.