The relevant range is the range of activity where the assumption that cost behavior is a straight line (linear) is reasonably valid. Managerial accountants like to assume that the relationship between a cost and an activity run in a straight line. As an example, if you make 10 widgets, and the direct materials in the widget cost $1, then the assumption would be that for each widget above 10, you would need to purchase another $1 worth of direct materials. However, if volume were to triple, there would likely be more fixed costs as the company will need more space and managers. Accordingly, we state that costs are fixed only in a relevant or reasonable range of activity.
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.
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.
In fact, teachers and students at the school being considered for closure were to be moved to other schools in the district, and so no savings on teachers’ salaries and benefits would result. The only real short-term cost savings would be in not having to maintain the classrooms, computer lab, and library (nonunion employees would be let go) and in utilities (heat and air markup learn how to calculate markup and markup percentage conditioning would be turned off). The only way to accurately predict costs is to understand how costs behave given changes in activity. To make good decisions, managers must know how costs are structured (fixed, variable, or mixed). The next section explains how to estimate fixed and variable costs, and how to identify the fixed and variable components of mixed costs.
Examples of Relevant Range
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.
- You could rent more space in your existing facility, if possible, or rent another facility.
- 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.
- As part of the process, review of each fixed cost currently incurred by the company is evaluated.
- They had to rent another space for $50,000 to store the extra finished goods inventory.
In particular, a “fixed” cost is likely to remain fixed only within a relevant range of activity. One way to understand a relevant range is to consider the task of preparing a budget for the upcoming year. As part of the process, review of each fixed cost currently incurred by the company is evaluated. The goal is to determine if any of those fixed costs are likely to increase during the new budget period, and if so what allowances must be made for that change.
relevant range definition
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.
The purchasing department must be aware of the quantity ranges within which volume discounts from suppliers are applicable. For example, a supplier may offer a 20% discount if the buyer orders a minimum of 10,000 units. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. After many years in the teleconferencing industry, Michael decided to embrace his passion fortrivia, research, and writing by becoming a full-time freelance writer. Since then, he has contributed articles to avariety of print and online publications, including SmartCapitalMind, and his work has also appeared in poetry collections,devotional anthologies, and several newspapers.
Relevant Range
Malcolm’s other interests include collecting vinyl records, minorleague baseball, and cycling.
What is the Relevant Range?
As another example, ABC Company assumes that the cost of a green widget is $10.00 within a relevant range of no less than 5,000 units per year and no more than 15,000 units per year. If the actual unit volume is less than 5,000 units, the purchased cost of materials increases sufficiently to make the assumed cost of $10.00 per unit too low. Conversely, if the actual unit volume is higher than 15,000 units, the https://www.kelleysbookkeeping.com/what-is-the-difference-between-adjusting-entries/ purchased cost of materials decreases sufficiently to make the assumed cost of $10.00 per unit too high. This example underscores the importance of understanding the relevant range when making decisions, as costs and operational needs can shift significantly outside of that range. Knowing her costs within the relevant range helps Maria to set appropriate pricing, budget efficiently, and predict profitability.
You start to panic a bit, but you hire more workers and start running three shifts per day. By reconfiguring your machinery to add more capacity, you are now able to make 40,000 mugs per month. Relevant range is one of those REALLY important concepts in managerial accounting.