What is a Sunk Cost?
A sunk cost refers to a cost that has already occurred and has no potential for recovery in the future. Given that sunk costs have already occurred, the cost will remain the same regardless of the outcome of a decision, and so they should not be considered in capital budgeting.
It is easy to get hung up on sunk costs, especially when they are explicit costs. Explicit costs are direct payments made to others in the course of running a business, such as wages, rent, and, materials.
- Explicit costs which have already been incurred are sunk and are irrelevant to future decision-making.
- Explicit cost
s which will occur in the future, however, are relevant to business decisions as they will be direct costs to the company that could be avoided.
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Sunk Costs are explicit and appear on financial statements so it is understandable why these costs are honed in on. Opportunity Costs are implicit and unseen, so they are often overlooked.
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