Join Jim Stice for an in-depth discussion in this video Stuck in the Beijing airport, part of Accounting Foundations: Managerial Accounting.
- Like any other field of study, managerial accounting has its own set of vocabulary, its own set of terms. - Many of these terms relate to different ways of thinking of costs. Is the cost fixed or is it variable? Is the cost an out of pocket cost or an opportunity cost? Is the cost a sunk cost? - Ah, sunk cost. Let me tell you a sunk cost story. This story happened just last month in the Beijing airport. I was stranded. - Stranded in the Beijing airport? How did that happen? - Well, that's another story, anyway, I was stranded in the Beijing airport.
I had a ticket bought and paid for that would get me out of town in two days. I called the airline trying to keep the tears out of my voice and they said, "This is not our problem. "We will make sure to confirm your reservation "for the flight in two days." - You had to hang around the Beijing airport for two days? - Well, that is where sunk costs come into play. For a few minutes, I was fixated on that ticket. I had already paid for that ticket. So I guess I needed to hang around Beijing for two days so that I could use it.
- Now, you and I have been to Beijing before, great city, so two days in Beijing is not bad. - No, not bad, I agree under normal circumstances, but I had some other obligations so I really couldn't spend two days doing some relaxed sight seeing in Beijing. I had to get out of town. But there was that ticket for which I had already paid and which I had been bluntly told by the airline was absolutely not refundable. I'm not going to tell you the name of this airline. So what to do? - Well, if you have to get out of Beijing and you don't have the flexibility to wait around for two days, then forget the ticket.
It's a sunk cost. Forget it. - Exactly, a sunk cost is a past cost that you can't change no matter what decision you make now. You've heard the phrase, "Don't cry over spilled milk?" Well in this saying, the spilled milk is the sunk cost. It's gone, finished, and there's nothing you can do about it, so move on. - Now, people have a very difficult time ignoring sunk costs. Those theater tickets that you've already paid for and now at the last minute insist on using even though it means rejecting a surprise visit from an old friend? The bad investment that you keep pouring money into because you want to try and get your original investment back? The shoes you keep wearing even though your feet hurt because you want to get your money's worth out of them? Yes, sunk costs are hard to ignore.
So, you're stranded in Beijing with this two days from now paid for ticket clutched in your hand, what did you do? - Finally, I came to my senses, and in my mind, I let to of the ticket, the sunk cost. - Well, then what? - Well, I was headed to Moscow, I looked at the departure board and I saw an Aeroflot flight leaving in just two hours. I went to the Aeroflot ticket counter, bought myself a ticket at a surprisingly reasonable price, and in two hours later, I was on my way. - And your original ticket? - Hey, what ticket? I've forgotten about it. That cost is sunk.
Want to hear more from Jim and Kay? Learn about all three types of accounting—financial, managerial, and income tax—in their Accounting Fundamentals course.
- Planning, controlling, and evaluating costs
- Controlling product flow costs
- Performing CVP analysis
- Understanding cost flows in different industries
- Understanding standard product costing and variances
- Understanding activity-based costing
- Capital budgeting