This lesson continues on from lesson 3 and should be seen as a continuation. You will need to review lesson 3 and the discussion on Economic versus Accounting Costs & Relevant Cost Analysis. In lesson 4, however, we will focus on Revenues & Measurement of Profitability and Risk & Uncertainty.

Relevant Costs in Decision Making
Based on the background covered in lesson 3, it is clear that for a farm that wishes to make decisions as a firm, a mix of economic and accounting cost skills will be handy. Relevant cost is an opportunity cost that should be used in a given decision making problem. Four illustrative devices are as follows; Depreciation cost measurement, inventory valuation, unutilized facilities and measurement of profitability.

Depreciation
Consider this scenario.

A farmer buys equipment worth 100,000.  How much is it worth in 10 years?

Typical accounting allocates depreciation based on expected number of years. If the equipment = 100,000, and is expected to last 20 years, straight line depreciation = 100,000/20 = 5,000/year.  Hence the equipment would be worthless (zero value) after 20 years.