Discretionary Costs

Discretionary Costs, also known as Managed Costs, are those costs incurred as a result of managerial decisions where the extent of these costs is subject to managerial discretion. These costs often relate to specific amounts or follow a pre-determined formula, such as a percentage of sales revenue. Examples include advertising and research expenditure.
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Discretionary Costs: A Detailed Overview

Discretionary costs refer to expenses that management has the authority to decide upon and control. These costs are typically variable and are often associated with discretionary activities that an organization can decide to cut or adjust based on its financial condition and strategic objectives.

Characteristics of Discretionary Costs

  1. Control and Flexibility: Managers have significant control over the amount and timing of these costs.
  2. Non-Mandatory Nature: Discretionary costs are not mandated by any legal or contractual obligations; instead, they are guided by internal policies and strategic goals.
  3. Budgeted Amounts: These costs can be set as a fixed amount in the budget or can vary based on a specific formula or criteria, such as a percentage of sales revenue.
  4. Strategic Importance: Though not essential for day-to-day operations, these costs are often important for long-term strategic investments and competitive positioning.

Examples of Discretionary Costs

  • Advertising Expenses: Costs associated with creating, producing, and running advertisements across various media platforms.
  • Research and Development (R&D): Expenses incurred for research projects, development of new products, and technological advancements.
  • Employee Training: Costs for ongoing education, training programs, and professional development initiatives.
  • Charitable Contributions: Donations made to non-profits, charities, or community projects which are alignment with the company’s corporate social responsibility policies.

Frequently Asked Questions (FAQs)

Q1: How do discretionary costs differ from committed costs?

  • A1: Discretionary costs are flexible and can be adjusted based on managerial decisions, whereas committed costs are fixed obligations that the company cannot easily adjust in the short term (e.g., lease payments).

Q2: Can discretionary costs be reduced during financial downturns?

  • A2: Yes, discretionary costs can be reduced or deferred during financial downturns as part of cost-cutting measures without immediately impacting the essential operations of the business.

Q3: Are discretionary costs typically higher in certain industries?

  • A3: Certain industries, such as pharmaceuticals and technology, often have higher discretionary costs due to significant investments in R&D and marketing activities.
  • Committed Costs: Fixed obligations a firm has incurred and must pay regardless of its level of production or sales.
  • Variable Costs: Costs that vary directly with the level of production, such as raw materials and direct labor.
  • Fixed Costs: Costs that remain constant regardless of the level of production, such as rent and salaries.

Online References

  1. Investopedia - Discretionary Costs
  2. Corporate Finance Institute - Discretionary and Non-Discretionary Costs
  3. Harvard Business Review - Managing Discretionary Expenses

Suggested Books for Further Studies

  1. “Accounting for Decision Making and Control” by Jerold Zimmerman - This book provides insights into how accounting information is used by managers in decision-making.
  2. “Cost Management: A Strategic Emphasis” by Edward Blocher, David Stout, and Gary Cokins - It provides comprehensive coverage on cost management for strategic use in business.
  3. “Management Accounting: Decision Making and Performance Management” by Will Seal, Peter Lohmann, Eric Noreen, and Paul Adams - Offers detailed exploration into various aspects of management accounting and the impact on business strategy.

Accounting Basics: “Discretionary Costs” Fundamentals Quiz

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