What are discretionary costs?

June 11, 2012

Learn about discretionary costs, view examples of such costs, and understand instances where discretionary costs may be changed to manage earnings.

1. Definition of discretionary costs

Discretionary costs are expenses that are important for the business but are subject to managementís judgment (discretion).

Discretionary costs are essentially voluntary costs incurred by an entity to meet customer expectations or create goodwill.

Discretionary costs are opposite to committed costs Ė i.e., expenses that an entity must incur to operate. Usually discretionary costs represent funding for a specific activity (or project) for a specified period of time.

Examples of discretionary costs are listed below (non-exhaustive list):

  • Advertising
  • Employee training and development
  • Employee travel
  • Executive retreats
  • Repairs and maintenance
  • Research and development (R&D)
  • Quality control
  • Social responsibility

Itís often difficult to measure the benefits of incurring discretionary costs because there is usually no clear relationship between cost input and product (service) output. As the result, when earnings decrease, an entity might cut discretionary costs first.

To evaluate output from discretionary costs, an organization could use nonmonetary measures: some examples are provided in the table below.

Discretionary Cost

Nonmonetary Measure of Output

Advertising

  • Increased unit sales
  • Increased market differentiation of the products
  • Increased price premiums
  • Increased numbers of coupons clipped and redeemed

Employee training

  • Increased employee effectiveness
  • Improved employee recruitment and retention
  • Improved product (or service) quality
  • Improved organizational performance and productivity

Preventive repairs and maintenance

  • Reduced equipment or process failures
  • Decreased unplanned downtime
  • Increased component life cycle
  • Extended equipment life
  • Increased equipment reliability

Quality control

  • Improved quality of products or services
  • Improved productivity
  • Increased customer satisfaction and loyalty

Social responsibility

  • Increased value of the firm
  • Increased market differentiation of the products
  • Increased price premiums
  • Competitor advantage opportunities
  • Decreased litigation risk
  • Increased entry-barriers for potential competitors
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