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decision making- cvp

aisha kapoor (90 Points)

27 February 2018

why is depreciation considered as a sunk cost?

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Mohit Suresh (plus twov) (310 Points)
Replied 28 February 2018

Hi Aisha,

1.sunk cost are those cost that have already been incurred and cannot be recovered. They are irrelevant future decision making as the cost cannot be avoided or changed by opting an alternative route.

2.Depreciation is a method of allocating cost of a tangible asset over it's span of life. Thus it represents a part of cost of the tangible asset.

3.Depreciation is normally calculated on a tangible asset purchased. Mark the word "purchased", it is in past tense. So the purchase of the asset is itself a cost that cannot be altered/recovered. Hence, depreciation,being a part of it, is a sunk cost.

Conclusion, just as cost of sunken Titanic became irrelevant to the owner for deciding whether to distribute rights for making it a film 😋, depreciation is sunk cost for decision making and hence irrelevant for decision making.

Note: In problem number 10 of chapter 2- CVP analysis. Even though it may seem depreciation is relevant for decision making, in effect it is really not.

Cheers.

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