A Company’s Relevant Range of Production is

MANAGEMENT Accounting CONCEPTS AND TECHNIQUES

By Dennis Caplan, University at Albany (State University of New York)

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Affiliate iv:�
Price Beliefs

Affiliate Contents:

–


Introduction

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Variable costs

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Fixed costs

–


Relevant range

–


Mixed costs

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Cost behavior assumptions in direction accounting versus microeconomics

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Exercises and bug

Introduction:

The most of import building block of both microeconomic analysis and toll accounting is the label of how costs change every bit output volume changes. Output volume can refer to production, sales, or any other principle activity that is advisable for the organization under consideration (east.g.: for a schoolhouse, number of students enrolled; for a health clinic, number of patient visits; for an airline, number of passenger miles). The post-obit discussion examines the volume of production in a factory, but the same principles apply regardless of the type of system and the appropriate measure of action.

Costs tin can be variable, fixed, or mixed.

Variable Costs:

Variable costs

vary in a linear way with the production level. Yet, when stated on a per unit basis, variable costs remain abiding across all production levels within the

relevant range
. The post-obit 2 charts draw this relationship between variable costs and output volume.

.

A good instance of a variable toll is materials. If one pair of pants requires $ten of textile, then every pair of pants requires $10 of fabric, no matter how many pairs are made. The fabric cost is $10

per unit of measurement

at every level of production. If i pair is made, the total fabric cost is $10; if two pairs are made, the full cloth cost is $20; and if 1,000 pairs are made, the total fabric toll is $10,000. Hence, the

total cost

is increasing and linear in the production level.

Fixed Costs:

Fixed costs

do non vary with the production level. Total fixed costs remain the same, inside the

relevant range
. Still, the fixed cost per unit decreases as production increases, because the aforementioned fixed costs are spread over more than units. The post-obit two charts depict this relationship between fixed costs and output volume.

In this case, fixed costs are $l,000. The start chart shows that fixed costs remain $50,000 at all production levels from 100 units to 1,000 units. The 2nd nautical chart shows that the fixed cost per unit decreases as product increases. Hence, when 100 units are manufactured, the stock-still cost per unit of measurement is $500 ($50,000 � 100). When 500 units are manufactured, the fixed price per unit is $100 ($l,000 � 500).

Relevant Range:

The

relevant range

is the range of activity (e.thousand., product or sales) over which these relationships are valid. For instance, if the factory is operating at chapters, increasing product requires additional investment in stock-still costs to expand the facility or to charter or build another manufacturing plant. Alternatively, production might exist reduced below a threshold at which indicate one of the company�s factories is no longer needed, and the fixed costs associated with that factory can be avoided. With respect to variable costs, the visitor might qualify for a book discount on fabric purchases to a higher place some product level. The relevant range for characterizing textile as a variable cost ends at that production level, because the fabric cost per unit of output is different when the factory produces to a higher place that threshold than when the factory produces below that threshold.

Mixed Costs:

If, within a relevant range, a price is neither stock-still nor variable, information technology is called

semi-variable

or

mixed
. Following are ii common examples of mixed costs.

In this case, although the full cost line increases in production, it does non pass through the origin because at that place is a fixed cost component. An case of a cost that fits this clarification is electricity. A fixed corporeality of electricity is required to run the mill air conditioning, computers and lights. At that place is as well a variable price component related to running the machines on the factory floor. The stock-still component in this instance is $3,000 per month. The variable cost component is $10 per unit of measurement of output. Hence, at a production level of 500 units, the total electric cost is $eight,000 [$three,000 + ($10 ten 500)].

The mixed cost illustrated in the higher up chart is called a step part. An example of such cost behavior would be the total bacon expense for shift supervisors. If the factory runs one shift, but one shift supervisor is required. In order for the mill to produce in a higher place the maximum capacity of a unmarried shift, the factory must add together a second shift and rent a second shift supervisor, and then that total shift supervisor salary expense doubles. If the factory runs iii shifts, iii shift supervisors are required.

Cost Behavior Assumptions in Management Accounting Versus Microeconomics:

Microeconomic analysis usually assumes decreasing marginal costs of production, sometimes followed past increasing marginal costs of production beyond a certain production level. Hence, economists� graphs of the total cost of production and the average per-unit cost of production testify smooth, curved functions. Management accountants usually assume the linear relationships depicted in the previous graphs. Linearity is a more than accurate description of many situations encountered by management accountants than the economists� curves, and even when linearity constitutes a simplifying assumption it is near ever sufficiently descriptive for the task at hand.��

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Management Accounting Concepts and Techniques; copyright 2006; most recent update: Nov 2010

For a printer-friendly version, contact Dennis Caplan at [email protected]