The relevant range is useful for analyzing cost behavior for management decision-making purposes.
The correct answer and explanation is :
Correct Answer:
The relevant range is the range of activity levels within which cost behavior assumptions hold true, meaning fixed costs remain constant, and variable costs per unit remain unchanged. It is useful for analyzing cost behavior for management decision-making because it helps managers make accurate cost estimations and avoid misinterpreting cost patterns outside this range.
Explanation:
In cost accounting, the relevant range is crucial for analyzing cost behavior and making sound managerial decisions. It defines the activity level limits within which cost structures remain predictable and stable. This concept applies to fixed costs and variable costs:
- Fixed Costs: These costs remain constant in total within the relevant range, regardless of changes in activity levels. For example, rent, salaries, and depreciation do not change unless operations exceed or fall below the relevant range.
- Variable Costs: These costs remain constant per unit within the relevant range. However, if activity moves beyond this range, bulk discounts, capacity constraints, or resource shortages might cause variations in per-unit costs.
Importance in Decision-Making:
- Budgeting and Forecasting – Managers use the relevant range to make accurate cost predictions and avoid unrealistic financial expectations.
- Break-even Analysis – Understanding cost behavior within the relevant range helps determine break-even points and profitability.
- Cost Control – Managers can identify cost efficiencies and avoid unnecessary expenditures by staying within the relevant range.
- Pricing Decisions – Knowing when costs might shift outside the relevant range helps set competitive and profitable prices.
For example, a factory’s fixed costs for machinery and rent apply only within a production range of 1,000 to 10,000 units. If production exceeds this, additional machines or space may be needed, altering cost behavior.
Thus, the relevant range is a fundamental concept that ensures cost assumptions remain valid for decision-making.
