What is Relevant Range?

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. Relevant range is a level of volume or activity within which a company is expected to operate.

All the budgeting and costing exercises are conducted with the relevant ranges as the fundamental assumptions. In other words, it is the underlying assumption when we comment certain costs to the fixed or variable.

Fixed costs may not be fixed and per unit variable cost may not be variable outside the relevant range of activity or volume.

The concept of the relevant range is particularly useful in two forms of analysis which are :

1. Budgeting

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.

2. Cost Accounting

The assumed cost of a product, service, or activity is likely to be valid within a relevant range and less value outside of the date range. In particular, a ‘fixed cost’ is likely to remain fixed only within a relevant range of activity. Also, volume discounts from suppliers are only valid for certain purchasing volume quantities.

Example:-

ABC Company constructs a budget within a relevant revenue range of no more than $20 million. If actual sales were to exceed that amount then ABC would need to construct a new manufacturing facility.

Relevant range in managerial accounting and cost accounting discipline is a crucial concert for managers. All the fundamentals of planning and controlling are based on the relevant range of operating activity of a company.

Therefore, it is of utmost importance to estimate the relevant range as close to actual as possible so that the planning and actions of the management are proved fruitful.

Relevant Range and Budgeting

The concept of the relevant range is a very important concept from various angles. It is the foundation for any budgeting exercise. Without defining the relevant range, it is impossible to effectively complete the budgeting process.  Let us see how with the help of an example.

Relevant Steel Ltd, a steel manufacturing company. Following is the activity level of last 5 years of the company.

Financial YearProduction in MT Tons
2009
2010
2011
2012
2013
250.00
312.50
390.63
488.28
610.35

While making cost budgets for the year 2014, one would need to forecast the various cost elements such as material cost, labor cost, utility cost, factory cost, administration cost, selling and distribution cost, etc.

All these costs are directly or indirectly dependent upon the level of activity of the business. Therefore, the budgeting manager should know the expected level of activity in the year 2014.

How to Calculate Relevant Range?

The growth rate of the company i.e. roughly 25% year on year can be taken as the basis for defining the relevant range of activity in 2014.

Other factors such as industry growth, competitors’ position, etc would play a role in defining the relevant range.

Relevant Cost and Cost Behaviour

1. Fixed Cost

2. Variable Cost

1. Fixed Cost

Fixed cost is fixed only in the relevant range. Beyond the range, it varies. It increases like a staircase.

2. Variable cost

Variable cost does not change in the same proportion as that of the output. The rate of increase may slow down.

Relevant Range and Behavior of Costs

Example of Fixed Cost

Fixed cost is fixed only in the relevant range. We normally understand supervisor salary as a fixed cost because that does not vary with the production.

If there are 2 machine producing 500 units each year and is supervised by one supervisor. He can supervise another 3 machines if installed nearby them.

So, till the requirement of the company is 2500 units per year, the same supervisor will handle and the cost of the supervisor will remain fixed to say $12000.

Over and above the production of 2500 units, the company will have to appoint and another manager to supervise the 6th machine onwards.

In the example, it is clearly evident that the supervisor cost which is a fixed cost is only fixed till the production is 2500 units. Here, the relevant range and fixed cost relation are as follows:

Fixed Cost Behavior at Relevant Ranges

Production (In Units)Supervisor Cost (Total Fixed Cost)
1 to 2500 Units
2501 to 5000 Units
5001 to 7500 units
$12,000
$24,000
$36,000

From the above table, we can make out another interesting thing about the behavior of costs with respect to relevant range. The fixed costs increase like stair steps.

Example of Variable Cost

We have learned a phrase that variable costs change proportionately with the changing production. No, the variable cost such as material does not change in the same proportion of the increase in production.

Undoubtedly, the variable cost will increase with production but the rate of increase will slow down. The reasons could be priced discounts due to bulk purchase etc.

Relevant Range and its implications

One of the assumptions of CVP analysis is that costs will behave in the same manner within the relevant range. The relevant range represents the activity level where the company reasonably expects to operate during a particular period of time.

Relevant Range quizlet

The range of activity index over which the company expects to operate during the year. Target Net income. The income objective is set by management variable costs.

Does the relevant range apply to fixed costs?

Fixed costs do not vary with the production level. Total fixed costs remain the same, within the relevant range. However, the fixed cost per unit decreases as production increases, because the same fixed costs are spread over more units.


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