Relevant Range

Published on :

21 Aug, 2024

Blog Author :

Edited by :

Reviewed by :

Relevant Range in accounting refers to the range of activities of a company within which specific cost behavior is not altered. It means the limit of production or other related activities within which the organization maintains the same level of costs.

The analysis will be helpful in a limited range of operations the company has previously operated in and is anticipated to operate. In other words, it displays the expected degree of activity at which the company will operate. Unless the company expands or contracts beyond what the pertinent range permits, these costs stay the same.

What Is Relevant Range?

The relevant range definition refers to the scope of a company's activities where specific cost behaviors remain unchanged, indicating the production or related activities limit where costs remain consistent.
It is essential for projecting accurate expenditures and revenue to formulate realistic budgets for upcoming periods.
Identifying a company's relevant range relies on assessing its current production capacity, which varies for each company and requires tailored estimations.
Understanding it enables managers to make informed choices that maximize profitability and efficiency within the constraints of the company's operations.

Relevant Range Explained

The relevant range is the anticipated amount of activity at which the company will operate. This applies to both fixed and variable costs averaged over the period assessed. The range is determined for businesses to project expenditures and revenue accurately to prepare practical budgets for the next period. For the same, the company evaluates the fixed costs it incurs in the desired period. The company determines if those costs will increase in the upcoming period and, if they do, what changes can be made to accommodate them.

Similarly, variable costs are evaluated for a possible increase, and steps to accommodate additional expenditures are taken. The budget prepared includes the limits of expected revenues. It is flexible and would increase or decrease based on expenses incurred. Any price or pricing information outside this specific range is unnecessary and need not be considered.

The fixed costs remain constant for a certain level of production. Unless the company expands or contracts beyond what the range permits, these expenses stay the same. For instance, the machines and manufacturing plants in a production facility are limited, such as producing only specific quantities in the stipulated time. Additional plants and machinery must be deployed if the facility plans to increase its production rate. This will increase the current rates of fixed costs in the organization.

Fixed expenses that display this behavior are called step costs. Therefore, fixed costs stay fixed over a specific range of activities, and the cost structures will be altered if they move outside that range of activities. However, if it has outgrown the appropriate range and if the production rises to the point where there comes a need to relocate or recruit more staff, fixed costs will change because of the increased rent and the added salaries.

How To Calculate?

Understanding relevant range cost accounting involves a systematic approach, starting with assessing business growth rates and evaluating current costs. Let's go into its details and understand the steps further.

Step 1: Determine the business growth rate.

The estimate can be compared to a previous period, industry, or competitor. The rate is calculated for the next accounting period.

Step 2: Calculate the current costs involved.

Calculating the cost of doing business at the current rate is essential to know the range. It is estimated by considering both fixed and variable costs.

Step 3: Calculation of the upper limit.

The estimated growth rate has to be compared with the current costs, which are then used to determine the amount of production it could support. The company shall consider the maximum possible production rates before increasing its fixed costs. If the maximum amount of growth does not exceed the present costs, it can be said that the costs are well within the range.

Step 4: Calculate the lower limit of the range.

This is the range where the growth affects the costs. Companies may need to cut back on their fixed costs to continue making a profit.

Examples

Let's understand the concept with the help of some examples.

Example #1

Consider a hypothetical company, XYZ, which operates two machines capable of producing 100 units of electronics each year. Additionally, the production team can supervise an additional two machines, bringing the total potential production capacity to 400 units annually. Let us assume the cost of supervising these machines totals $10,000 per year.

Within this scenario, the company's production capacity is constrained within a range of 1 to 100 units. Operating within the relevant range ensures that fixed costs remain stable. However, producing beyond the relevant range may incur additional fixed costs, highlighting the significance of the company's actual capacity.

Now, the company aims for 100% growth and plans to double its production. If the goal is to produce 800 units (an increase from 400 to 600 units), the company would need to incur $20,000 in expenses. Similarly, if the target is to produce 1200 units (an increase from 801 to 1200 units), the cost would rise to $30,000.

Example #2

Let us take another example of a company, ABC. The company is a product manufacturing company with a team working in it. The team manager who was hired and the team had a salary budget of $100,000. This amount is the expense to maintain ten people. The team, however, had only five people, and the cost was manageable. They did need to stay the same. The team would naturally grow if the company made additional sales and needed additional production capacity.

It needs the addition of human resources(20), and the previous manager will need help to handle it. To accommodate new growth, the company has to sign up for an additional manager and a team under him to handle the additional workload and pay another $100,000. This means that the range has increased. From 5-10 people (initial range), there was no need for the company to endure additional costs in the form of giving out salaries as the production increase could be maintained with the already allocated sum.

Frequently Asked Questions (FAQs)

Why is relevant range important to a manager?

The relevant range is crucial for managers as it delineates the scope within which cost behavior remains consistent. Understanding relevant range helps managers make informed decisions regarding production levels, resource allocation, and budgeting. By staying within the relevant range, managers can predict and control costs more effectively, ensuring optimal performance and profitability for the company.

How are constrained resources and relevant ranges related?

Resource constraints and ranges can be associated with each other concerning planning. Relevant ranges help plan the budget, which is a monetary resource. When there is an error in estimating the proper range, adequate resources may not be available, which can reduce profit.

Is the relevant range the normal range of output?

Yes, the relevant range refers to the normal range of output within which certain cost behaviors remain consistent. It represents the level of activity where fixed and variable costs behave predictably. Operating within a relevant range allows companies to budget and plan for their expenses accurately.