Question

In: Accounting

MR X claims that the relevant range concept is important only for variable costs. I. Explain...

MR X claims that the relevant range concept is important only for variable costs.
I. Explain the relevant range concept.
II. Do you agree with Mr X claim? Explain.
III. “The relevant range is indispensable in cost behavioranalysis.” Is this true? Why or why not?

Solutions

Expert Solution

I. 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.

In simple terms, we can say that “The range over which a company expects to operate during a year is called the relevant range of the activity index.”

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

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.

Cost accounting:- The assumed cost of a product, service, or activity is likely to be valid within a relevant range, and less valid outside of that 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.

II. Disagree with Mr. X claim. The behaviour of both fixed and variable costs are linear only over a certain range of activity. CVP analysis is based on the assumption that both fixed and variable costs remain linear within the relevant range.

III. This is true. Most companies operate within the relevant range. Within this range, it is possible to establish a linear (straight-line) relationship for both variable and fixed costs. If a relevant range cannot be established, segregation of costs into fixed and variable becomes extremely difficult.


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