Relevant range and cost behavior analysis

What is relevant range?

Relevant range is one of those REALLY important concepts in managerial accounting. It’s pretty major but it does not get the attention it deserves. Most professors and authors blow by it pretty quickly but it is a foundational concept that most other assumptions rely on.

When looking at costs and how costs behave, relevant range is the range of output or production in which our assumptions are true. If you move outside the relevant range, your cost assumptions are no longer valid.

An example regarding relevant range and fixed costs

Let’s say that you run a company that makes travel coffee mugs that can keep your coffee hot for 14 hours. The rent on your production facility is $4,000 per month. Running one shift per day, your employees can produce 10,000 mugs per month. One day, you wake up and your overnight sales were 7,000 mugs. Over the course of the day, you get 20,000 more orders. A celebrity was seen with your coffee mug and now everyone wants one!

You start to panic a bit, but you hire more workers and start running three shifts per day. By reconfiguring your machinery to add more capacity, you are now able to make 40,000 mugs per month. Even with the excess capacity, you still can’t keep up with the orders. You just can’t make more than 40,000 mugs per month.

What do you do? You could rent more space in your existing facility, if possible, or rent another facility. Either of those options means that you will pay more for rent. Your fixed costs will go up because you cannot make more units with your existing $4,000 per month rental cost.

In this example, your monthly rent of $4,000 has a relevant range of zero units to 40,000 units. If you want to make more than that, you are outside the relevant range and will incur additional costs.

graph showing relevant range, both inside and outside the relevant range

 

Why is relevant range important?

Relevant range is important because if you make the assumption that all of your costs will remain constant, whether they are fixed or variable, you may make errors on your projections. Also, if you ignore relevant range, you may hit capacity issues where you don’t realize you physically cannot make all of the goods needed because you have hit your capacity for the time period.

About the Author Kristin

Kristin is a Certified Public Accountant with 15 years of experience working with small business owners in all aspects of business building. In 2006, she obtained her MS in Accounting and Taxation and was diagnosed with Hodgkin's Lymphoma two months later. Instead of focusing on the fear and anger, she started her accounting and consulting firm. In the last 10 years, she has worked with clients all over the country and now sees her diagnosis as an opportunity that opened doors to a fulfilling life. Kristin is also the creator of Accounting In Focus, a website for students taking accounting courses. Since 2014, she has helped over one million students succeed in their accounting classes.

follow me on:
>

Finals are coming! Let Professor Ingram show how to make finals suck less in her free Finals Survival Guide.