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Sunk Cost Examples

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Example #1 - Research and Development

Almost all industries will have Research and development expenses in their books, and companies will be spending massive money on research and development purposes for their product.

A drug manufacturing company, A, invests $ 2,50,000/- for many years for R & R & R&D on a new drug for hair growth. However, when the company launched this product in the market, doctors stopped recommending that pill to their patients due to some side effects faced by many patients. This issue forced the company to stop the production of that pill. In this case, $ 2,50,000/- has become a sunk cost, so it should not be considered in any decision for this product in the future.

Example #2 - Marketing Expenses

Sunk cost is also known as unrecoverable cost as the amount that cannot be recovered, which has already been spent on some business activities. For example, almost all businesses spend on marketing and advertisement to promote their products and services. The amount which has already been spent on marketing and advertising cannot be recoverable. So, advertising and marketing expenses should not be considered in the decision-making process.

Let’s consider the example of Company A, which is into two-wheeler manufacturing and have a vast product line in their portfolio. Recently, the company has launched one new two-wheeler model, and the board has decided to spend $5,00,000 on marketing and advertisement to promote its new product. Although they have not succeeded in this marketing campaign as the product efficiency was not up to the mark.

The company has already spent $5,00,000 on this failed marketing campaign. Still, they should not consider this expense in any future decision-making for the same product or any other company product. This amount will be regarded as a Sunk cost.

Example #3 - Equipment Expenses

Whether small or big production machinery, the equipment cost tends to become sunk cost over time. Most manufacturing companies would have a vast product line in their portfolio, and most are not similar. Companies have to invest in different kinds of machinery for different products. Not a single machine can produce all types of products. Sometimes, most of the old machinery or the products they manufacture are not in fashion at present. Companies have to replace that machinery with new upgraded machinery.

In this case, companies can resell the machinery, but in no case, they can recover the whole amount which was spent initially. So, the amount which is not recoverable would be considered as Sunk Cost.

A Company XYZ is into the manufacturing of kid toys. They manufacture different kinds of small or big size toys, soft toys, and mechanical toys. They initially spent $ 1,00,000 on purchasing equipment and machinery for their manufacturing plant. Over time, due to the change in the toy industry, the company needed advanced kinds of machinery, and the board decided to replace old machinery with new ones. The company has sold old machinery at $ 20,000 as scrap, and the remaining $80,000 became sunk cost in the case. They should not consider that amount which was spent on old machinery for any future decisions,

Example #4 - Payroll Expenses

Whether it’s a small firm or big firm, manufacturing industry, or service industry, all have payroll expenses. Payroll Accounting Expenses include salaries, employees’ benefits, and employee training expenses, which would always become sunk costs once the amount is paid to the payroll head.

The amount already spent on employees, directly or indirectly, cannot be recovered. This is because it does not affect employee performance or behavior.

For example, A company spent $ 10,000 to train its staff to use its newly introduced ERP system. Initially, it was working as per the plan. Still, after a few months, the ERP system was found unreliable and unproductive due to changes in office culture. The company wanted to replace the ERP system and had to train its employees again to use a new ERP system. In the first case, the training expenses of $10,000 would be considered a sunk cost as it was an expense that would not be recovered in the future and not at all useful in any future business activity.

Conclusion

A sunk cost is also called a Past Cost, which does not affect the present business situation. Any money spent on any project should be considered an individual project cost. We can conclude the above decision in the following points,

A sunk cost is a cost that has already been spent but is not recoverable in any case, and future business decisions should not be affected by past spending.
Spending on research, equipment, or machinery buying, rent, payroll, marketing, or advertising is the main example of sunk cost. Other examples are equipment or machinery that produces only specific products or spending on processes for customized products for specific customers.
Some industries, such as drug manufacturing, research companies, heavy machinery manufacturing, would have more sunk costs, so it would have a major barrier of entry for new entrants in these industries.
Sunk costs should not be considered when making any future decisions for the same or different products or services.