Activity Analysis, Cost Behavior and Cost Estimation

1
Activity Analysis, Cost Behavior and Cost
Estimation

• The relationship between cost estimation, cost
  behavior and cost prediction.

Cost Estimation
Cost Behavior
Cost Prediction
For managers to predict how costs will be
affected by changes in an organization, they must
understand the relation between these three
categories and use a little magic.
Magic
2
Cost Behavior Patterns

• Total variable cost increases in direct
  proportion to the change in activity level, but
  the variable cost per unit remains constant.
• Fixed cost per unit decreases as the activity
  level increases, but the total fixed cost remains
  constant.
• A semi-variable cost has both a fixed and a
  variable component.
• A relevant range is the range of activity within
  which management expects the organization to
  operate.

3
Cost Definitions

• An engineered cost results from a definitive
  physical relationship with the activity measure.
  (e.g. direct raw materials)
• A committed cost results from an organizations
  ownership or use of facilities and its basic
  organization structure. (e.g. property taxes and
  building depreciation)
• A discretionary cost results from a discretionary
  management decision to spend a particular amount
  of money. (e.g. research development)
• Discretionary costs can be changed in the short
  run much more easily than committed costs.

4
Cost Estimation

• Cost estimation is the process of determining how
  a particular cost behaves.
• The cost analyst classifies each cost item in the
  ledger as variable, fixed or semi-variable.
• Three methods to estimate cost
• The visual-fit method draws a cost line through a
  scatter diagram according to the visual
  perception of the analyst.
• The high-low method fits a cost line to the data
  using the high activity and low activity data
  points.
• The least-squares regression method minimizes the
  sum of the squared deviations between the cost
  line and the data points.