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. These changes in variable costs per unit could be caused by circumstances beyond their control, such as a shortage of raw materials or an increase in shipping costs due to high gas prices. In any case, average variable cost can be useful for managers to get a big picture look at their variable costs per unit. In cost behavior analysis, relevant range represents the production bracket expressed in terms of units within which fixed costs are indeed fixed.
Excessive costs may even be a red flag that possible fraud is occurring. Cost accounting helps ensure that financial costs are within an acceptable range and helps an organization make reliable forward-looking financial decisions. The https://business-accounting.net/ 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.
One of the key features of this work was making the sensor highly specific for detecting lead ions. The researchers used an aptamer, which is a short, single strand of DNA or RNA, as the ion receptor. These receptor molecules are known for their inherent selectivity toward specific ions. The researchers further enhanced the receptor’s binding affinity for lead ions by tailoring its DNA or RNA sequence. This ensured that the sensor would only be triggered upon binding to lead ions. All responses should recognize that there is no room in the car for the seventh girl and her luggage, although the condominium will accommodate the extra person.
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. 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.
- However, for every night that a room is rented, Ocean Breeze must remit an additional tax amount of $5.00 per room per night.
- These receptor molecules are known for their inherent selectivity toward specific ions.
- There is also a variable
cost component related to running the machines on the factory floor. - Two of the broadest and most common grouping of costs are product costs and period costs.
- The down side to this approach is that once the new QA inspector is hired, if demand falls again, the company will be incurring fixed costs that are unnecessary.
To examine how these mixed costs actually work, consider the Ocean Breeze hotel. As defined earlier, the relevant range is a term used to describe the range of activity (units of production in this example) for which cost behavior patterns are likely to be accurate. The relevant range for total production costs at Bikes Unlimited is shown in Figure 5.8. It is up to the cost accountant to determine the relevant range and make clear to management that estimates being made for activity outside of the relevant range must be analyzed carefully for accuracy.
Supplier Discounts Relevant Range
For example, Carolina Yachts has production supervisors who oversee the manufacturing process but do not actively participate in the construction of the boats. Their wages generally support the production process but cannot be traced back to a single unit. For this reason, the production supervisors’ salary would be classified as indirect labor.
We see that total fixed costs remain unchanged, but the average fixed cost per unit goes up and down with the number of boats produced. As more units are produced, the fixed costs are spread out over more units, making the fixed cost per unit fall. Likewise, as fewer boats are manufactured, the average fixed costs per unit rises. We have spent considerable time identifying and describing the various ways that businesses categorize costs. It is important not only to understand the categorization of costs but to understand the relationships between changes in activity levels and the changes in costs in total. It is worth repeating that when a cost is considered to be fixed, that cost is only fixed for the relevant range.
Examples of Relevant Range
The average variable cost will be $70.00 per person per day, no matter how many people go on the trip. However, the total variable costs will range from $70.00, if Pat goes alone, to $350.00, if five people go. Figure 2.26 shows the relationships of the various costs, based on the number of participants. The total fixed costs for the trip will be $720.00, no matter whether Pat goes alone or takes up to 4 friends. However, the average fixed costs will be the total fixed costs divided by the number of participants. The average fixed cost could range from $720 (720/1) to $144 (720/5).
Major Cost Behavior Patterns
Two specialized types of fixed costs are committed fixed costs and discretionary fixed costs. These classifications are generally used for long-range planning purposes and are covered in upper-level managerial accounting courses, so relevant range they are only briefly described here. Although this is probably a more accurate description of how variable costs actually behave for most companies, it is much simpler to describe and estimate costs if you assume they are linear.
Two of the broadest and most common grouping of costs are product costs and period costs. If, at any point, the average variable cost per boat rises to the point that the price no longer covers the AVC, Carolina Yachts may consider halting production until the variable costs fall again. When labor costs are incurred but are not directly involved in the active conversion of materials into finished products, they are classified as indirect labor costs.
For instance, wages often act as a stepped variable cost when employees are paid a flat salary and a commission or when the company pays overtime. Further, when additional machinery or equipment is placed into service, businesses will see their fixed costs stepped up. The relevant range, in managerial accounting and cost accounting, refers to the range of activity within which certain assumptions about cost behavior are valid. In other words, it’s the range of production or sales volume where the total fixed costs remain constant, and the variable cost per unit stays the same. Outside this range, these assumptions may no longer hold, and costs may behave differently. Many businesses can make decisions by dividing their costs into fixed and variable costs, but there are some business decisions that require grouping costs differently.
(1) Pay the quality inspector overtime in order to have the additional units inspected. The advantage to handling the increased cost in this way is that when demand falls, the cost can quickly be “stepped down” again. Because these types of step costs can be adjusted quickly and often, they are often still treated as variable costs for planning purposes. The mixed cost illustrated in the
above chart is called a step function. An example of such cost behavior would
be the total salary expense for shift supervisors.
This is the “relevant range,” and it’s a critical qualifier when budgeting and allocating fixed costs. As you have learned, much of the power of managerial accounting is its ability to break costs down into the smallest possible trackable unit. In many cases, businesses have a need to further refine their overhead costs and will track indirect labor and indirect materials. Now that we have identified the three key types of businesses, let’s identify cost behaviors and apply them to the business environment. In managerial accounting, different companies use the term cost in different ways depending on how they will use the cost information. Different decisions require different costs classified in different ways.
This means they will have to either find a larger vehicle and incur higher gas expenses or take a second car, which will at least double the fixed gas cost. He is considering his costs for the trip if he goes alone, or if he takes one, two, three, or four friends. However, before he can begin his analysis, he needs to consider the characteristics of the costs.