Activity Analysis, Cost Behavior, and Cost Estimation

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7
Chapter Seven

• Activity Analysis, Cost Behavior, and
  CostEstimation

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Introduction
Costestimation
Process ofdeterminingcost behavior,often
focusingon historicaldata.
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Identifying Cost Drivers
Activities thatcause costs to be incurred are
calledcost drivers.
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Identifying Cost Drivers
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Cost Classifications
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Question?

• Fixed costs are really variable. The more you
  produce, the less they become.

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Step-Variable Costs
Total cost remainsconstant within anarrow range
ofactivity.
Cost
Activity
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Step-Fixed Costs
Total cost doesnt change for a wide range of
activity, and then jumps to a new higher cost for
the next higher range of activity.
Cost in Dollars
0
Activity
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Step-Fixed Costs
Step-variable costs can be adjusted more quickly
and . . . The width of the activity steps is much
wider for thestep-fixed cost.
How does this type of fixed cost differ from a
step-variable cost?
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Semivariable Cost

• A semivariable cost is partly fixed and partly
  variable.

Consider thefollowing electric utility example.
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Semivariable Cost
Total semivariable cost
Variable Utility Charge
Total Utility Cost
Fixed MonthlyUtility Charge
Activity (Kilowatt Hours)
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Curvilinear Cost
CurvilinearCost Function
Activity
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Engineered, Committed and Discretionary Costs
Discretionary May be altered in the short term by
current managerial decisions.
Committed Long-term, cannot be reduced in the
short term.
Engineered Physical relationship with activity
measure.
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Shifting Cost Structure in the New Manufacturing
Environment

• A trend toward more fixed costs because of
• Increased automation.
• Stable workforce.

Implications Managers are more locked-in with
fewer decision alternatives. Planning becomes
more crucial because fixed costs are difficult to
change with current operating decisions.
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Summary of Costs to Date

• Variable, Fixed, Step-Variable, Step-Fixed,
  Semivariable (mixed) (Total per unit)
• Product (inventoriable) or Period
• Direct or Indirect
• Controllable or Uncontrollable
• Conversion, prime, total manufacturing
• Differential, Marginal, Opportunity, Sunk, Out-of
  Pocket
• Engineered, committed, discretionary

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Question
7-35 page 286
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Cost Estimation
Account-Classification Method
Visual-Fit Method
High-Low Method
Least-Squares Regression Method
Engineering Method of Cost Estimation
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Account Classification Method
Cost estimates are based on areview of each
account making up the total cost being analyzed.
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Visual-Fit Method

• A scatter diagram of past cost behaviormay be
  helpful in analyzing mixed costs.
• Place a line through the points to yield a cost
  function.

Exercise 7 30 as an example Page 285
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(No Transcript)
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The High-Low Method

• Cost estimation method that is computed using
  exactly two data points
• You choose the high and low activity levels NOT
  the high and low cost levels
• As with the visual-fit method, the estimate is
  restricted to the relevant range

Exercise 7 29 as an example
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Least-Squares Regression Method

• Regression is a statistical procedure usedto
  determine the relationship between variables such
  as activity and cost.

The objective ofthe regressionmethod is
thegeneral cost equation Y a bX in cost
terms TC F VX
Total Cost
Activity
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Multiple Regression

• Multiple regression includes two or more
  independent variables
• Terms in the equation have the samemeaning as
  in simple regression withonly one independent
  variable.

TC FC V1X1 V2X2
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Data Collection Problems

• Missing data.
• Outlier data points.
• Mismatched time periods costs.
• Trade-offs in choosing the time period.
• Allocated and discretionary costs.
• Inflation.
• Stable relationship over time.

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Engineering Methodof Cost Estimation
Direct Labor
Direct Material
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Costs and Benefits of Information
More information does not mean more benefits if
information overload results.
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End of Chapter 7
7-24, 7-27, 7-33