Opportunity Costs in Managerial Accounting
Sometimes choosing one alternative means losing money because you turned down another alternative. These costs are called opportunity costs. For example, suppose you can either visit your mother in Peoria or work on an internship. Choosing to go to Peoria means you lose the internship income. You don’t actually have to pay for this choice because you never got the internship income in the first place.
However, you miss out on money you could’ve received if you hadn’t gone to visit your mother. Your opportunity costs result from income not earned because you decided to do something else.
(Relevant costs, on the other hand, are costs that you actually incur and pay because you chose the alternative that brought them on. Here’s the difference: If Mom’s the jealous type, choosing the internship over visiting her may, in the long run, may bring on relevant costs far worse than the opportunity cost of missing the internship.)
In business, opportunity costs commonly arise from the reality that businesses have limited resources. Say an arcade decides to replace an old pinball machine with a new video game. The income lost from the old pinball machine represents the opportunity cost arising from this decision.