What is a Sunk Cost?
A sunk cost is a cost which a business has already incurred and which cannot be recovered in the future. As these historical costs cannot change, they should not be taken into account when making future decisions.
Suppose for example, a business has already incurred significant costs in research and development for a new product. If it is concluded that the future revenues from the product will not cover the future costs, and the product will be loss making, then the business should ignore the sunk costs and cancel the future development of the product.
The tendency to keep going with future investment due to the substantial sunk costs is referred to as the sunk cost effect.
For further information see the Wikipedia Sunk Costs definition.
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About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years in all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.