a particular activity level bound by a minimum and maximum amount.
Relevant Range Details
The relevant range is considered a standard range of volume or the average quantity of activity. The total or cumulative amount of a company’s fixed cost will not change as the quantity or amount of activity changes. Fixed cost refers to the total amount of expenses expected to be paid by a company. It is a cost that does not increase or decrease in the number of goods and services produced or sold. Within the specified boundaries, particular revenue or expense levels are assumed to take place. Outside this expected relevant range, revenues and expenses will most likely be different from the expected amount.
The term “relevant range” is essential in two forms of analysis: budgeting and cost accounting.
- Budgeting occurs when a company or an organization develops a plan on how to spend their money. It estimates the revenue (the income earned by a company through the provision of specific goods and services) and expenses (the cost incurred during the process of making goods and services available) that cover a specified time in the future. It usually collates and is reevaluated regularly. It makes certain assumptions about the relevant range of activities within which the business expects to operate.
- Cost Accounting refers to a set of procedures used for recording and reporting the measurement of cost to manufacture goods and perform services in total and detail. It includes different methods for recognizing, classifying, allocating, aggregating, and reporting costs and then comparing them with the standard charges. It helps a company control its costs and make strategic planning and decision to improve cost efficiency.
Example of Relevant Range
Alex is a manufacturer whose monthly production is consistently between 20,000 to 50,000 units of the product requiring between 30,000 to 35,000 machine hours. Within this relevant range of activities, the company’s manufacturing operations run smoothly with the same amount or quantity of monthly fixed costs. On average, a fixed cost is approximately $300,000 per month, covering the cost of supervisors, rent, depreciation, and other fixed expenses.
However, suppose Alex’s manufacturing volume were to drop to 15,000 units of product or 20,000 machine hours. In that case, it might likely reduce the number of Alex’s supervisors, the rented space for manufacturing, and other fixed costs to reduce the $300,000 monthly fixed expenses.
On the other hand, if Alex’s manufacturing volume were to increase to 55,000 units of products or 40,000 machine hours, Alex’s manufacturing company will likely have to increase its total fixed cost or pay additional supervisors, manufacturing space, and other fixed expenses. Afterward, Alex’s company’s fixed costs are approximately $300,000 every month within a relevant activity range.
Significance of Relevant Range
Relevant range helps organizations or companies deal with mistakes in their projections. How? If an organization or company assumes that all their cost will remain constant, it might lead to errors in their projection. If they ignore their relevant range, unanticipated capacity issues might arise, preventing them from producing all the needed goods simply because they have hit their capacity for a particular time.
Relevant range is also significant because if a cost estimate is done for a specific activity or occurrence beyond the relevant range, the total fixed costs and variable costs for each unit may differ from those specified in the equation. For instance, if manufacturing or production is increased, there might be a need for additional space or additional working supervisors, resulting in higher fixed costs.