Question

1. Describe the term relevant range. Why is it important to stay within the relevant range when estimating costs?
2. Describe the variables in the cost equation Y = f + vX.

Answer 1

1. Relevant range is a level of volume or activity within which a company is expected to operate. All the budgeting and costing exercise are conducted with relevant range as the fundamental assumption. In other words, it is the underlying assumption when we comment certain costs to be 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.

Relevant range in managerial accounting and cost accounting discipline is a crucial concept 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 BEHAVIOR OF COSTS

Example of Fixed Cost

‘Fixed cost is fixed only in relevant range’. We normally understand supervisor salary as fixed cost because that does not vary with the production. Now, look at the example below:

If there are 2 machines producing 500 units each per year and is supervised by 1 supervisor. He can supervise another 3 machine if installed nearby them. So, till the requirement of the company is 2500 (500*5) units per year, the same supervisor will handle and cost of supervisor will remain fixed to say $12,000. Over and above the production of 2500 units, the company will have to appoint another manager to supervise 6^th machines 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	$12,000
2501 to 5000 Units	$24,000
5001 to 7500 Units	$36,000

2.

What are fixed costs? (F IN THE EQUATION)

• Fixed costs do not change with output, firms must pay these even if they shut down
• Examples include the rental costs of buildings; the costs of leasing or purchasing capital equipment; the annual business rate charged by local authorities; the costs of employing full-time contracted salaried staff; the costs of meeting interest payments on loans; the depreciation of fixed capital (due solely to age) and also the costs of business insurance.
• Any business with significant capacity will have high fixed costs, for example a vehicle manufacturer that spends millions of pounds building a new factory and installing expensive and bulky capital equipment.

What are Variable Costs?( V IN THE EQUATION)

• Variable costs vary directly with output – when output is zero, variable costs will be zero but as production increases, total variable costs will rise

  Examples of variable costs include the costs of raw materials and components, packaging and distribution costs, the wages of part-time staff or employees paid by the hour, the costs of electricity and gas and the depreciation of capital inputs due to wear and tear

X IN THE EQUATION IS THE TOTAL UNITS OF OUTPUT PRODUCED