What are sunk costs?

Sunk costs refer to costs that have already been incurred and cannot be recovered. Once these costs have been spent, they are considered 'sunk' because they cannot be retrieved or affected by any future decisions. This characteristic of sunk costs makes them irrelevant in decision-making processes because future decisions should be based on marginal costs and benefits rather than past expenditures.

Understanding sunk costs is crucial in management accounting, as businesses must learn to disregard these expenses when evaluating potential opportunities or projects. Concentrating on future costs and revenues helps ensure that decisions are made based on relevant information, leading to better financial outcomes.

In contrast, costs that can be recovered in future sales are not sunk costs, as they imply a potential for reclaiming funds. Projected costs for future projects and expenses calculated for budgeting forecasts deal with anticipated financial commitments and planning, which also do not pertain to the concept of sunk costs.