Definition: A Sunk Cost is the cost already incurred by the firm and cannot be recovered or refunded. The cost which was incurred in the past and is now permanently lost is called as a Sunk Cost.
Suppose, a firm has spent Rs 50,000 in the construction of a building, but due to some government law the construction has to be stopped, then the amount spent till date is a sunk cost.
A sunk cost is considered irrelevant for making the business decisions, and hence, the economists consider only the future cost, that will be incurred in the future, while taking the decisions for a particular project.
Suppose a company spent thousands of rupees on the installation of an ERP system, but however, the system installed is inadequate to meet the current needs of an organization. Hence, the management will look out for the ways to improve the system on the basis of cost that will be incurred on improvisation. Thus, the cost already spent on the system does not play any role in the decision-making process.
A sunk Cost is only considered to justify the choices made in the past, i.e. whether the amount spent in the past fulfilled the purpose and if not, then how much more amount is to be spent or if the project is to be withdrawn, such decisions are made.