Definition: A sunk cost, also known as a stranded cost, is an expense that has already occurred and can’t be changed or avoided. In other words, it’s a cost that has already been paid and can’t be refunded or reduced. It’s in the past and has no bearing on any future decision making processes.
What Does Sunk Cost Mean
What is the definition of sunk cost? Just like the name implies, sunk costs are gone and can’t be recovered. Accountants focus on this fact when making business decisions because costs that occurred in the past should not affect the actions in the future.
Example
Take a new market for example. When a business decides to branch out into a new market or product line, it can spend large amounts of money on market research, product development, and advertising. After a failed entrance attempt into the market, many managers tend to focus on the overall past investment into a project as a reason to keep it going. They don’t want to see all the money, time, and energy spent trying to infiltrate a market lost by pulling out, so they continue to “invest” in the project.
This is an ineffective way of looking at the situation. Previously spent research, development, and advertising dollars are sunk costs and are unavoidable. They have no bearing on the current decisions that will affect the future. These costs are in the past and should not be a reason to continue to pour money into a loosing market, segment, or product. Instead, managers should ignore these previously spent costs and focus on the current market. If it has potential, they should continue to invest. If it looks like it will continue to lose money, they should stop investing and end the operations.
All large corporations have faced this dilemma at some point in their history. Microsoft faced this situation after a failed attempt to infiltrate the portable MP3 player market with the Zune. After a large failed product launch, Microsoft ceased Zune production and cut its losses.
Summary Definition
Define Sunk Cost: Sunk costs are expenses that a company has already incurred and avoid no matter what course of action it takes.
