11.10: Avoidable Costs
Learning Outcomes
- Describe avoidable costs
It is Thursday night and you are deciding whether you should go out for dinner or stay in and make a pizza. If you decide on the pizza, a quick run to the grocery store would be needed. But dinner at your local Mexican restaurant is sure sounding nice. What costs could be avoided if you chose to eat the pizza at home? What if you chose to go out for dinner?
By choosing to go out to eat, you can avoid the cost of groceries, so the cost of groceries is an avoidable cost. Conversely, by choosing to eat at home, you can avoid the cost of the restaurant meal, so the cost of the meal is an avoidable cost. But whether you decide to eat at home or at the local restaurant, you still need to pay for your house right? The mortgage on your house is not an avoidable cost, as whether you choose to eat at a restaurant, or eat at home, the mortgage payment is still due.
So we would all like to avoid costs, right? But what is an avoidable cost?
An avoidable cost is one that can be eliminated completely depending on the alternative we pick.
An avoidable cost is a relevant cost, while unavoidable costs are irrelevant costs. Since we have to pay the mortgage no matter what, we can disregard that cost when we make decisions, right?
Let’s look at another example. Let’s revisit our friends at Simply Yoga.
Simply Yoga is looking at streamlining its class schedule. Currently, they have 50 classes running, with 10 students each. They would like to streamline to 20 classes with 25 students each to save money. What would be an avoidable cost in this situation?
| Classes taken | 500 | 500 |
|---|---|---|
| Number of classes offered | 20 | 50 |
| Revenue ($14/class) | $7,000 | $7,000 |
| Expenses | ||
| Wages and salaries ($7/person or $84/class) | $3,500 | $4,200 |
| Yoga supplies | $250 | $300 |
| Utilities (300 + $10/hour) | $500 | $800 |
| Rent | $500 | $500 |
| Insurance | $100 | $100 |
| Other expenses | $250 | $300 |
| Total expense | $5,100 | $6,200 |
| Net operating income | $1,900 | $800 |
The additional wages, supplies, utilities and other expenses could be avoided by reducing the number of classes. Rent and insurance are unavoidable costs, as they will happen regardless of how many classes happen or how many students attend.
So we can disregard rent and insurance as we figure out how to make Simply Yoga more profitable, right? Those costs will make no difference in the decision we ultimately make or how many classes we hold.
Practice Questions