What is relevant range?

what is the relevant range

The school district ultimately decided not to close the school because of the large committed fixed costs involved, as well as a lack of community support, and budget cuts were made in other areas throughout the district. We discuss the relevant range concept in more detail later in the chapter. For now, remember that the accuracy of cost behavior patterns is limited to a certain range of activity called the relevant range. When identifying a relevant range, there is a strong need to make use of factual information. While it is possible to develop some sort of range using all sorts of criteria, including hopes and dreams for the future of the company, those may or may not be grounded in reality. What sets a relevant range apart is that the process calls for remaining grounded in what has a reasonable chance of occurring during the upcoming budgetary period and making allowances for those events.

  1. Your fixed costs will go up because you cannot make more units with your existing $4,000 per month rental cost.
  2. By reconfiguring your machinery to add more capacity, you are now able to make 40,000 mugs per month.
  3. In this example, your monthly rent of $4,000 has a relevant range of zero units to 40,000 units.
  4. Perhaps we get a discount after we purchase 100 components, at which time the cost of direct material will drop to .80 per widget.
  5. In accounting, the term relevant range usually refers to a normal range of volume or normal amount of activity in which the total amount of a company’s fixed costs will not change as the volume or amount of activity changes.

To reduce costs, the school district’s administration decided to consider closing one of the smaller elementary schools in the district. According to an initial estimate, closing this school would reduce costs by $500,000 to $1,000,000 per year. However, further analysis identified only $100,000 to $150,000 in cost savings. Review this section to be sure you understand variable, fixed, and mixed costs.

If actual sales were to exceed that amount, then ABC would need to construct a new manufacturing facility. The relevant range refers to a specific activity level that is bounded by a minimum and maximum amount. Within the designated boundaries, certain revenue or expense levels can be expected to occur. Outside of that relevant range, revenues and expenses will likely differ from the expected amount. The concept of the relevant range is particularly useful in two forms of analysis, which are noted below.

What is a Relevant Range?

Hopefully, they get manufacturing and sales aligned before that happens, but for now, that is the new relevant range. Now, let’s say the popularity of ZenSpace grows, and Maria anticipates more than 25 students per class. She will then have to consider renting a larger space or offering additional classes, both of which could change the cost structure. The cost assumptions within the original relevant range (0-25 students) no longer apply once she expands beyond that range. A school district outside Sacramento, California, was faced with making budget cuts because of a reduction in state funding.

When a company constructs a budget for a future period, it makes assumptions about the relevant range of activities within which the business is likely to operate. As long as the actual activity volume falls somewhere within the relevant range, and other assumptions are valid, budgeted revenues and expenses are more likely to be correct. In this case, the relevant range is most likely to be fairly close to the current activity level of a business, with minor modifications. Most of the costs were committed fixed costs (e.g., teachers’ salaries and benefits) and could not be eliminated in the short term.

what is the relevant range

Hence, an experienced accountant would say that the company’s fixed costs are approximately $200,000 per month within a relevant range of activity. For example, suppose Bikes Unlimited’s production capacity is 8,000 units per month, and management plans to expand capacity in two years by renting a new production facility and hiring additional personnel. https://www.online-accounting.net/understanding-budget-period/ This is a long-term decision that will change the cost behavior patterns identified earlier. Variable production costs will no longer be $60 per unit, fixed production costs will no longer be $20,000 per month, and mixed sales compensation costs will also change. All these costs will change because the estimates are accurate only in the short term.

Relevant Range

Malcolm’s other interests include collecting vinyl records, minorleague baseball, and cycling.

what is the relevant range

Above that amount, a new relevant range can be assumed for a different cost that assumes the inclusion of the cost of the shift supervisor in the cost of the product. Relevant range is important because if you make the assumption that all of your costs will remain constant, whether they are fixed or variable, you may make errors on your projections. Also, if you ignore relevant range, you may hit capacity issues where you don’t realize you physically cannot make all of the goods needed because you have hit your capacity for the time period. You could rent more space in your existing facility, if possible, or rent another facility. Your fixed costs will go up because you cannot make more units with your existing $4,000 per month rental cost.

BUS610: Business Intelligence and Analytics

Doing so means the chances of being overwhelmed by shifts in the economy are lessened, which in turn means the business has a better chance of surviving whatever chain of events should come to pass. In this example, your monthly rent of $4,000 has a relevant range of zero units to 40,000 units. If you want to make more than that, you are outside the relevant range and will incur additional costs. When looking at costs and how costs behave, relevant range is the range of output or production in which our assumptions are true. If you move outside the relevant range, your cost assumptions are no longer valid. The new warehouse will be big enough until they reach 55,000 bikes, so the total rent will remain at $150,000 until that time.

Cost Behavior Patterns

Perhaps we get a discount after we purchase 100 components, at which time the cost of direct material will drop to .80 per widget. With variable costs then, the relevant range will be the range where the cost of adding one more, will be the same as the last. In this example, from widgets, each additional widget will add $1 in cost to our direct materials. As a fourth example, ABC Company constructs a manufacturing facility, which has a fixed cost of $10 million to operate and maintain every year. However, if production levels exceed 3 million units per year, then this fixed cost will increase, because of additional wear and tear on the facility. Thus, the relevant range of this fixed cost is up to a maximum of 3 million units per year.

At the same time, variable costs will be evaluated and a range of possible movement with those expenses created to accommodate any expectations of increase or decrease in those average costs. For example, assume Bikes Unlimited’s mixed sales compensation costs of $10,000 per month plus $7 per unit is only valid up to 4,000 units per month. If unit sales increase beyond 4,000 units, management will hire additional salespeople and the total monthly base salary will increase beyond $10,000. Once the company exceeds sales of 4,000 units per month, it is out of the relevant range, and the mixed cost must be recalculated. Let’s assume that a manufacturer’s monthly production volume is consistently between 10,000 to 13,000 units of product requiring between 20,000 to 25,000 machine hours.

Most professors and authors blow by it pretty quickly but it is a foundational concept that most other assumptions rely on. During the financial year 2014, sales dropped but they debits and credits normal balances permanent and temporary accounts kept producing bikes so they ended up with too many bikes to store in the rented space. They had to rent another space for $50,000 to store the extra finished goods inventory.

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