Definitions and meanings:
In relation to a decision or project, relevant costs are those costs that only affect that particular decision or project and those costs are irrelevant or unnecessary for any other project. It means that if any cost arises due to taking up of a certain decision or undertaking a project and that cost will not occur otherwise can be called its relevant costs. These costs are normally incremental and avoidable cost.
For example, a business has to determine whether to terminate or continue production of a specific product. The business will take into consideration all the costs it could bear and revenues lost if it stops the production of that product. These costs and revenues will be relevant to that product only. Now, if for example, business can save cost of labor and material of $4,560 and loses revenues of $4,200. The relevant cost for the business will be $360.
Differential cost is the difference between the costs of different alternative projects or opportunities. Differential costing is applied when a business entity has an option to pursue a single project or opportunity but has a variety of projects or opportunities to choose from. In such situations, the business will have to drop the unfavorable projects based upon the difference in costs.
For example, a business has to produce a certain product. The demand for that product is 3,000 units in a year. Now the business can either automate the production process for $10,000 or it can hire manual labor for $12,000 to complete the production. The $2,000 difference of cost between these two options will be considered as the differential cost for the business.
Difference between relevant cost and differential cost:
The main points of difference between relevant cost and differential cost are given below:
The technique of relevant costing is applied to a single decision. It considers all the incremental costs attached to that particular decision and only considers one project at a time. While technique of differential costing is applied when there are more than one decisions. It considers all the revenues and costs of those projects to identify the difference between them.
2. Decision Criteria:
As relevant costing is applied to a single decision, it is used to decide whether a particular project is feasible for the management of the business to pursue or not. While differential cost considers different decisions. So, it is used to determine the best project based on its costs and revenues after comparing them with each other.
The relevant costing can only be used to calculate the incremental costs of distinct projects. Therefore, results of different projects cannot be compared to make sensible decision, because each project will have its own relevant cost which may or may not affect the other project. While, differential costing considers the change in the levels of output as well as any marginal costs attached to it for all the different available projects and then compares the results to make well-informed decisions.
Both of these costing techniques are management tools which help management of a company to make well-versed and practical decisions. Where relevant costing makes management to focus only on the costs that are relevant, which not only saves time but prevents the possibility of making an incorrect decision, differential costing considers the increased levels of output, its marginal cost and direct difference between the total costs of different projects to present a practical comparison of all the available options to the management of that company. The management can also consider other options market competitiveness, market share, the timeline of potential projects etc. while making the final decision.