Relevant Range Accounting for Managers

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 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.

• Assuming the activity is the number of bikes produced and sold, examples of fixed costs include salaried personnel, building rent, and insurance.
• In fact, a single cost, such as rent, may be classified by one company as a fixed cost, by another company as a committed cost, and by even another company as a period cost.
• The third major classification of product costs for a manufacturing business is overhead.
• To examine how these mixed costs actually work, consider the Ocean Breeze hotel.

Sierra Company is trying to identify the behavior of the three costs shown in the following table. Calculate the cost per unit, and then identify how each cost behaves (fixed, variable, or mixed). A relevant cost is also defined as a cost whose amount will be affected by a decision being made.

The Relevant Range (Managerial Accounting)

The term mixed cost5 describes a cost that has a mix of fixed and variable costs. For example, assume sales personnel at Bikes Unlimited are paid a total of $10,000 in monthly salary plus a commission of $7 for every bike sold. This is a mixed cost because it has a fixed component of $10,000 per month and a variable component of $7 per unit. A committed fixed cost3 is a fixed cost that cannot easily be changed in the short run without having a significant impact on the organization. For example, assume Bikes Unlimited has a five-year lease on the company’s production facility, which costs $8,000 per month.

• Out of the overall profits, which come to $1,200 per night, each server receives $200.
• By understanding what is within their relevant range, businesses can make more informed decisions and plan for the future with greater accuracy and success.
• One way to understand a relevant range is to consider the task of preparing a budget for the upcoming year.
• In the following year, it sells 70 motorcycles, prompting the purchase of an additional 60 green exhaust pipes.
• Relevant costs include differential, avoidable, and opportunity costs.

For example, a supplier may offer a 20% discount if the buyer orders a minimum of 10,000 units. If the order declines to 9,000 units, then only a 10% discount applies. A monetary system under which countries pledge to maintain their exchange rates
within a specific margin around agreed-upon, fixed central exchange rates. 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. 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. Looking at this analysis, it is clear that, if there is an activity that you think that you cannot afford, it can become less expensive if you are creative in your cost-sharing techniques.

Cost Accounting Relevant Range

Your maximum growth rate remains within your relevant range if it doesn’t exceed your costs. You’ve reached the upper limit of your relevant range once your growth rate necessitates adjusting your fixed costs. For instance, a company can create a budget that allots profit distributed to shareholders if it is planning its growth over the next ten years to share with prospective shareholders and investors. The business deducts the cost of doing business from the anticipated revenue to arrive at this calculation. The cost of labor to produce the product and the fixed cost of the warehouse used to store the inventory are then calculated. With these calculations, the company establishes the relevant range.

What is relevant range?

Similarly, if the company’s volume were to increase dramatically, the company would likely have to increase the total amount of its fixed costs . Budget projections are created by businesses to plan for future growth and to update shareholders. In order to do this, assumptions must be made regarding the pertinent gamut of activities they might engage in during the budgetary period. These presumptions enable businesses to calculate costs based on their fixed expenses.

The key to relevant costing is the ability to filter what is and isn’t relevant to a business decision. In the boat example, what about the $10,000 ($25,000 original sales price -$15,000 sold price) I just loss? Sunk costs are costs programs that limit that have been incurred in the past, do not affect future costs and cannot be changed by any current or future actions. Managerial and related cost accounting systems assist managers in making ethical and sound business decisions.

relevant costing

Cost 3 is a mixed cost because as the number of units produced changes, total cost changes (but not in proportion to changes in activity) and per unit cost changes. Table 5.2 provides the total and per unit fixed costs at three different levels of production, and Figure 5.2 graphs the relation of total fixed costs (y-axis) to units produced (x-axis). Note that regardless of the activity level, total fixed costs remain the same.

As an example, relevant cost is used to determine whether to sell or keep a business unit. The opposite of a relevant cost is a sunk cost, which has already been incurred regardless of the outcome of the current decision. A clear understanding of relevant costs will aid in your future decision making abilities. 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. Where Y is the total mixed cost, a is the fixed cost, b is the variable cost per unit, and x is the level of activity.

ABCMotorcycles can continue operating within this pertinent range for an additional five years at its current growth rate. By the sixth year, the company’s 10-unit-per-year growth rate equals over 120 units sold, forcing it to raise fixed costs once more. These costs don’t change unless your company expands or contracts more than what your relevant range permits.

However, before he can begin his analysis, he needs to consider the characteristics of the costs. Some of the costs will stay the same no matter how many people go, and some of the costs will fluctuate, based on the number of participants. The purchasing department must be aware of the quantity ranges within which volume discounts from suppliers are applicable.

For Carolina Yachts, their direct labor would include the wages paid to the carpenters, painters, electricians, and welders who build the boats. Like direct materials, direct labor is typically treated as a variable cost because it varies with the level of activity. However, there are some companies that pay a flat weekly or monthly salary for production workers, and for these employees, their compensation could be classified as a fixed cost.