# Cost Classification for Decision Making

For decision making, costs are classified as B1–B3.

## B1: Variable, Fixed & Semi-Variable Cost

Type	Behaviour with activity level
Variable Cost	Directly varies with the volume of activity
Fixed Cost	Does not vary with the change in volume; remains constant irrespective of volume
Semi-Variable Cost	Contains both fixed and variable components; partly affected by a change in activity level

## B2: Sunk Cost

Costs that have been irreversibly incurred or committed and therefore cannot be considered relevant to a decision. Also termed irrecoverable costs.

> For decision making, sunk costs are ignored — the money is already spent and cannot be recovered by any future choice.

## B3: Opportunity Cost

The value of the best alternative course of action that was NOT chosen. It is what could have been accomplished with the resources had they been employed in the next best alternative. It represents opportunities foregone.

> Opportunity cost does not involve an actual cash outflow — it is the benefit given up, yet it IS relevant to decisions.

Worked example

### Example 1

Sunk cost illustration: A machine was bought for ₹5,00,000 two years ago. Today, deciding whether to replace it, the ₹5,00,000 already spent is a sunk cost — it is irrelevant to the replace-or-keep decision because it cannot be recovered.

### Example 2

Opportunity cost illustration: A trader can use his shop to either sell garments (profit ₹40,000) or electronics (profit ₹55,000). If he chooses garments, the opportunity cost is ₹55,000 — the profit from the best foregone alternative (electronics).

⚠️ Common exam mistakes

Including sunk costs in a decision analysis — they are irrelevant because they are irreversible.
Ignoring opportunity cost because there is no cash outflow — it is still a relevant cost in decision making.
Calling a cost 'fixed' permanently — fixed costs are fixed only with respect to volume of activity within a relevant range.

Reference:

Now that you've read this — what's next?

Move from understanding → mastery in 3 clicks. Each option below picks up from this lesson's topic.

🔥 Drill 5 Qs on this → ✍️ Adaptive practice →

Cost Classification for Decision Making (Variable/Fixed, Sunk, Opportunity)

Worked example

⚠️ Common exam mistakes