What are sunk costs?

Sunk costs refer to expenses that have already been incurred and cannot be recovered. This concept is particularly significant in management accounting and decision-making because these past costs should not influence ongoing or future decisions. The rationale is that decisions should be based on future benefits and costs rather than past investments that cannot be altered.

For example, if a company has invested significant resources in a project that is now deemed unviable, those expenses are sunk costs. Managers should focus on the future implications of their choices rather than the amount already spent, which cannot be reclaimed. This understanding helps in preventing the "sunk cost fallacy," where decision-makers continue investing in a failing project simply because they have already incurred significant costs.

This concept stands in contrast to future costs or recoverable costs, which are relevant for decision-making. Focusing on sunk costs can lead to poor financial decision-making, so it is crucial to recognize their nature properly.