Short-Term Decision-Making: Short Term Versus Long Term and the Relevant Range Saylor Academy

what is the relevant range

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 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.

what is the 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.

What is a Relevant Range?

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 If you move outside the relevant range, your cost assumptions are no longer valid.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.

  1. 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.
  2. 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.
  3. She will then have to consider renting a larger space or offering additional classes, both of which could change the cost structure.
  4. However, if volume were to triple, there would likely be more fixed costs as the company will need more space and managers.

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.

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.

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.

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 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.

Supplier Discounts Relevant Range

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 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.

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

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.

Cost Accounting 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.

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.

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 filing taxes as a self employed canadian 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.

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, https://www.quick-bookkeeping.net/invoice-requirements-eu-vat/ 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.


Posted

in

by

Tags:

Comments

Leave a Reply

Your email address will not be published. Required fields are marked *