CHAPTER 1: Management Accounting Defined, Described, and Compared toFinancial Accounting

CHAPTER 1: Management Accounting Defined, Described, and Compared toFinancial Accounting

If she expects to operate outside of that range, she’ll need to adjust her cost assumptions and business strategy accordingly. Costs that do not change with increases or decreases in the volume of goods or services
produced, within the relevant range. The costs that do change as the number of participants change are the variable costs. The food and lift ticket expenses are examples of variable costs, since they fluctuate based upon the number of participants and the number of days of activities.

• Revisiting Tony’s T-Shirts, Figure 2.16 shows how the variable cost of ink behaves as the level of activity changes.
• Although this is probably a more accurate description of how variable costs actually behave for most companies, it is much simpler to describe and estimate costs if you assume they are linear.
• His fixed costs still remained fixed in total and his total variable cost rose as the number of T-shirts he produced rose.

Nearly every student and parent stated that college attendance was an expectation from an early age. To prepare for this goal, students took challenging courses focused on their strengths. A monetary system under which countries pledge to maintain their exchange rates
within a specific margin around agreed-upon, fixed central exchange rates.

Constantly Improve Your Study Process: How Grant Passed His CPA Exams

As an example, if you make 10 widgets, and the direct materials in the widget cost $1, then the assumption would be that for each widget above 10, you would need to purchase another $1 worth of direct materials. 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 15 best practices in setting up and sending nonprofit newsletters 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. A prepaid cell phone plan might include a base rate of $30 for 1G of data and $5 for each additional 300 megabytes of data.

• However, before he can begin his analysis, he needs to consider the characteristics of the costs.
• These classifications are generally used for long-range planning purposes and are covered in upper-level managerial accounting courses, so they are only briefly described here.
• For each sale of a unit of product or service, one unit of variable cost is incurred.

The distributor charges $10 per bike for shipping for 1 to 10 bikes but $8 per bike for 11 to 20 bikes. If Bert wants to save money and control his cost of goods sold, he can order an 11th bike and drop his shipping cost by $2 per bike. It is important for Bert to know what is fixed and what is variable so that he can control his costs as much as possible. Identification of relevant range is important because knowing the production level at which costs will change is critical for cost accounting, budgeting and financial planning. Since we categorize costs as either fixed or variable, the combination of the two gives us total costs for various levels of production. The following table illustrates fixed and variable cost behaviors using the book example and assuming that the number of units manufactured all fit within our current existing operating capacity.

Relevant & Irrelevant Costs for Decision-Making

Table 2.6 summarizes how costs behave within their relevant ranges. For example, let’s say Bikes Unlimited picks up a large contract with a customer that requires producing an additional 30,000 units per month. Do you think the cost equations in Table 5.5 would lead to accurate cost estimates?

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. We have established that fixed costs do not change in total as the level of activity changes, but what about fixed costs on a per-unit basis? Let’s examine Tony’s screen-printing company to illustrate how costs can remain fixed in total but change on a per-unit basis.

relevant range

Relevant range is one of those REALLY important concepts in managerial accounting. Most professors and authors blow by it pretty quickly but it is a foundational concept that most other assumptions rely on. For example, ABC Company constructs a budget within a relevant revenue range of no more than $20 million.

Relevant range

Fixed costs remain the same in terms of their total dollar amount, regardless of the number of units manufactured or sold. These are general expenditures that cannot be traced to any one item sold and may include electricity, insurance, depreciation, salary, and rent expenses. The mixed cost illustrated in the
above chart is called a step function. An example of such cost behavior would
be the total salary expense for shift supervisors. If the factory runs one
shift, only one shift supervisor is required. In order for the factory to
produce above the maximum capacity of a single shift, the factory must add a
second shift and hire a second shift supervisor, so that total shift supervisor
salary expense doubles.

Different decisions require different costs classified in different ways. For instance, a manager may need cost information to plan for the coming year or to make decisions about expanding or discontinuing a product or service. In practice, the classification of costs changes as the use of the cost data changes. 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. Understanding different cost classifications and how certain costs can be used in different ways is critical to managerial accounting.

Hence the cost of material is relevant cost as long as the material not purchased because of deciding whether or not to purchase the material, one is to decide to sustain the cost or evade it. While in the example Carolina Yachts is dependent upon direct labor, the production process for companies in many industries is moving from human labor to a more automated production process. For these companies, direct labor in these industries is becoming less significant.