Definition: An avoidable expense, also called an escapable expense, is a cost that is that will not occur if a department is closed, operation is cancelled, or product is discontinued. In other words, it’s an expense that can be avoided by eliminating specific operations.
Management must study avoidable costs when considering downsizing the company, discontinuing products, or relocating operations because these expenses are costs that the company can eliminate if certain action is taken.
For example, if a factory is performing poorly and continually losing money each quarter, management might consider consolidating the department or eliminating it altogether. Before the drastic decision is made to close a department or branch, you have to look at the costs that will be eliminated.
Let’s assume a manufacturer is considering closing one of its factories. What expenses would be eliminated if the factory closed? The company would not incur the salaries, rent, utilities, and depreciation of equipment related to the factory when it is closed.
Other expenses that affect the company as a whole like advertising, insurance, administrative expenses, and general expenses would all still be present. These are considered the unavoidable costs because the company can’t get rid of them even if they close the doors to the factory.
The decision to close the factory is a balance between the avoidable expenses that will be eliminated and the unavoidable costs that will remain. This decision ultimately comes down to whether or not the factory’s revenue is less than the avoidable expenses.
What Does Avoidable Expense Mean?
Even then, sometimes management finds that a factory, department, or branch that continually loses money each period is worth keeping simply because it helps contribute to the unavoidable expenses of the company as a whole. Mergers and consolidations are complex and require careful analysis by management. In the end, the final decision could be left up to management’s judgment about whether the department has future potential.