Definition
Discretionary costs are expenses that management can easily adjust or change based on the business’s strategic decisions and financial requirements. These costs are not essential for the basic operations of the business but can have a significant impact on its competitive positioning and long-term growth. Examples of discretionary costs include:
- Advertising: Expenses incurred in promoting the company’s products and services.
- Repairs and Maintenance: Costs associated with maintaining or repairing equipment and facilities.
- Research and Development (R&D): Investments made in developing new products, improving existing ones, or exploring innovative processes.
Discretionary costs are often the first to be reduced or eliminated when a company faces financial difficulty or looks to stabilize earnings.
Examples
- Advertising Campaigns: A company might scale up its advertising budget during peak seasons or cut back during economic downturns.
- Repair Services: Maintenance activities can be deferred or accelerated based on current financial goals.
- R&D Projects: Investment in new research can be ramped up during prosperous times or cut back when resources are tight.
Frequently Asked Questions (FAQs)
Q1: Why would a company reduce discretionary costs?
A1: Companies might reduce discretionary costs to manage cash flow, improve profit margins, or stabilize earnings during financial difficulties.
Q2: Can discretionary costs impact a company’s long-term growth?
A2: Yes, cutting discretionary costs, particularly in areas like R&D, can hinder long-term growth and innovation.
Q3: Are discretionary costs consistent year-over-year?
A3: No, discretionary costs can vary significantly based on management’s decisions and the company’s financial condition.
Q4: How do discretionary costs differ from fixed and variable costs?
A4: Fixed costs remain constant regardless of business activity, and variable costs change with production volume. Discretionary costs are adjustable at management’s discretion based on strategic priorities.
Q5: Should discretionary costs always be minimized?
A5: Not necessarily. While reduced discretionary costs can improve immediate financial performance, consistently low investment in areas like marketing and R&D can undermine a company’s competitive position over time.
- Fixed Costs: Costs that do not change with the level of production or business activity.
- Variable Costs: Costs that vary directly with the level of production.
- Operating Expenses: Expenses required for day-to-day functioning of a business.
- Capital Expenditure: Funds used by a company to acquire or upgrade physical assets.
Online References
Suggested Books for Further Studies
- “Cost Management: A Strategic Emphasis” by Edward Blocher, David Stout, and Paul Juras
- “Managerial Accounting” by Ray H. Garrison, Eric Noreen, and Peter C. Brewer
- “Accounting for Decision Making and Control” by Jerold Zimmerman
- “Principles of Cost Accounting” by Edward J. Vanderbeck and Maria R. Mitchell
Fundamentals of Discretionary Cost: Cost Management Basics Quiz
### Which of the following is considered a discretionary cost?
- [ ] Rent
- [x] Advertising
- [ ] Salaries of factory workers
- [ ] Utilities
> **Explanation:** Advertising is a discretionary cost, as it can be easily adjusted based on management decisions, unlike fixed expenses like rent or variable expenses like salaries tied to production.
### Why might a company increase its discretionary costs?
- [x] To invest in activities for future growth such as R&D
- [ ] To lock in fixed long-term contracts
- [ ] To cut production costs
- [ ] To pay off loans early
> **Explanation:** A company might increase discretionary costs to invest in future growth opportunities, such as research and development, rather than to secure fixed contracts or reduce existing costs.
### Discretionary costs are often categorized under which type of expense in financial reporting?
- [ ] Fixed Costs
- [ ] Variable Costs
- [x] Operating Expenses
- [ ] Capital Expenses
> **Explanation:** Discretionary costs are typically categorized as operating expenses because they are associated with the day-to-day operations but can be managed and adjusted by the company's decisions.
### In a financial downturn, which type of costs are businesses most likely to cut?
- [x] Discretionary Costs
- [ ] Fixed Costs
- [ ] Mandatory Costs
- [ ] Depreciation
> **Explanation:** During a financial downturn, businesses are most likely to cut discretionary costs, such as advertising and R&D, as they are easier to adjust compared to fixed or mandatory costs.
### Which of the following would typically NOT be affected by changes in discretionary costs?
- [ ] Long-term innovation
- [ ] Marketing effectiveness
- [x] Equipment depreciation rates
- [ ] Staff training programs
> **Explanation:** Changes in discretionary costs do not affect equipment depreciation, which is a fixed expense based on the initial cost and useful life of the equipment.
### How can cutting discretionary costs affect a business in the long run?
- [x] It can negatively impact growth and innovation.
- [ ] It always results in immediate profit gains.
- [ ] It has no impact on the company's operational efficiency.
- [ ] It guarantees a stable cash flow.
> **Explanation:** While cutting discretionary costs can improve short-term financial performance, it can negatively impact the company's long-term growth and innovation potential.
### Which type of budget is most influenced by discretionary costs?
- [ ] Capital Budget
- [x] Operating Budget
- [ ] Financial Budget
- [ ] Personal Budget
> **Explanation:** The operating budget is most influenced by discretionary costs, as it includes day-to-day expenses that management can adjust based on the company’s strategic needs.
### Research and Development (R&D) is considered a discretionary cost. What is an investment in R&D supposed to develop?
- [x] New products, services, and processes
- [ ] Increase in the workforce
- [ ] Reduction of fixed costs
- [ ] Long-term debt repayment
> **Explanation:** Investments in R&D are directed toward developing new products, services, and processes, fostering innovation and future growth for the business.
### Advertising expenses fall under which cost category?
- [x] Discretionary Costs
- [ ] Fixed Costs
- [ ] Variable Costs
- [ ] Capital Costs
> **Explanation:** Advertising expenses are labeled as discretionary costs since they can be scaled up or down based on strategic decisions made by management.
### What is a potential consequence of consistently reducing discretionary costs?
- [ ] Increased cash flow without any strategic impact
- [ ] Improved operating efficiency without risks
- [x] Potential loss of competitive advantage and stifled innovation
- [ ] Guaranteed financial stability
> **Explanation:** Consistently reducing discretionary costs, such as cutting back on advertising or R&D, can lead to a loss of competitive advantage and may stifle innovation, impacting long-term success.
Thank you for delving into the intricacies of discretionary costs. By understanding and managing these costs strategically, you can better navigate financial challenges and secure long-term growth for your business.
