What Are Discretionary Costs? A Clear Definition

Discretionary costs are expenditures a business can choose to incur or not. They are not strictly necessary for short-term operations or profitability. Instead, management incurs them for strategic purposes or to enhance the business. The ability to adjust or eliminate these expenses provides financial flexibility.

Characteristics of Discretionary Costs

Discretionary costs are non-essential for immediate, day-to-day operations or the production of goods and services. While they may contribute to long-term success, a business can operate in the short term without them.

These costs result from a conscious management decision, driven by strategic objectives rather than operational necessity. Unlike unavoidable commitments, discretionary costs can be adjusted, reduced, or eliminated without severe disruption to core functions. They do not increase or decrease directly with changes in production volume, setting them apart from costs tied directly to output.

Common Examples of Discretionary Costs

Many types of business spending are discretionary. Advertising and marketing campaigns are prime examples; a company can temporarily scale back or halt these efforts without stopping production. Similarly, investments in research and development (R&D) are discretionary, as companies choose to allocate funds for future innovation, but immediate operations do not depend on this spending.

Employee training and development programs, beyond mandatory compliance, also represent discretionary costs. These initiatives enhance employee skills but are not strictly necessary for immediate business continuation. Other examples include charitable donations, office aesthetic improvements, and employee perks like company parties or gym memberships.

Differentiating from Other Cost Types

Discretionary costs differ from fixed costs, which are recurring and consistent regardless of production volume. Fixed costs, like rent or insurance, are unavoidable commitments a business must pay to operate. Discretionary costs, however, are optional. The key distinction lies in their necessity and management’s choice to incur them.

Discretionary costs also differ from variable costs, which fluctuate directly with changes in production or sales volume. Raw materials and direct labor costs, for instance, increase as more products are manufactured. Discretionary costs do not exhibit this direct relationship with output, as they are not driven by the volume of goods or services produced.

Discretionary costs also stand apart from essential operating costs, sometimes called committed costs. Essential operating costs, such as utility bills or loan repayments, are necessary for fundamental business functioning and are difficult to avoid. Discretionary costs, however, can be foregone or adjusted without immediately jeopardizing operations. This flexibility makes them a primary target for reduction when a business faces financial constraints or seeks to conserve cash.