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Depreciation represents an allocation of a cost already incurred. It is a sunk cost, a cost that cannot be affected by any future action. Although we allocate this sunk cost to future periods and call that allocation depreciation, none of the original cost is avoidable. Sunk costs are always the same across alternatives and, therefore, always irrelevant. Thus, depreciation costs, like all sunk costs, fail to possess the two characteristics required of relevant costs and, therefore, always are irrelevant. In choosing between the two alternatives, the original cost of the power saws and their associated depreciation are not relevant factors. However, it should be noted that salvage value of the machinery is a relevant cost for certain decisions. For example, if Audio-Blast decides to transform itself into a distributor, not a producer, of speakers, the amount that can be realized from the sale of the power equipment will be relevant and will be included as a benefit of the switch to distributor status. Finally, it is i
mportant to note the psychology behind managers’ treatment of sunk
costs. Although managers should ignore sunk costs for relevant decisions, such as whether or not to continue funding a particular product in the future, it unfortunately is human nature to allow sunk costs to affect these decisions. For example, Toshiba and its HD DVD product team engaged in a fierce, multi-year battle with Sony and its Blu-ray product team for recognition as the universally accepted format in the growing next-generation high-definition DVD market.