DSS-ESTIMATING COSTS

1
DSS-ESTIMATING COSTS

2
Introduction
Costbehavior
Using results ofcost estimationto forecast
alevel of cost ata particularactivity.
Focusis on the future.
Existingrelationshipbetweencost andactivity.
Process ofestimating relationship between
costsand cost driveractivities that cause
those costs.
3
Reasons for Estimating Costs
Management needsto know the costs thatare
likely to beincurred for eachalternative.
4
Reasons for Estimating Costs
BetterDecisionsAdd Value
AccurateCostEstimates
ImprovedDecisionMaking
5
Reasons for Estimating Costs
Exh. 11-1
Relationship between activities and costs
3. To reduce these
1. First, identify this
Costs

• We estimate costs to
• manage costs
• make decisions
• plan set standards

2. Then manage these
Activities
6
One Cost Driver and Fixed/Variable Cost Behavior
Exh. 11-2
Slope Cost Driver Rate
.16
Intercept Fixed Cost
7
Nonlinear Costs
CurvilinearCost Function
Activity
8
The High-Low Method
The high-low method uses two points to estimate
the general cost equation TC F ? VX
TC the value of the estimated total cost
F a fixed quantity that represents the
value of Y when X zero
V the slope of the line, the unit
variable cost .
X units of the cost driver activity.
9
The High-Low Method
The high-low method uses two points to estimate
the general cost equation TC F VX
20







Total Cost in1,000s of Dollars



10
The two points should be representative ofthe
cost and activity relationship over the rangeof
activity for which the estimation is made.
0
0 1 2 3 4
Activity, 1,000s of Units Produced
10
The High-Low Method

• WiseCo recorded the following production activity
  and maintenance costs for two months
• Using these two levels of activity, compute
• the variable cost per unit
• the fixed cost and then
• express the costs in equation form TC F VX.

11
The High-Low Method

• Unit variable cost 3,600 4,000 units
  .90 per unit
• Fixed cost Total cost Total variable cost
• Fixed cost 9,700 (.90 per unit 9,000
  units)
• Fixed cost 9,700 8,100 1,600
• Total cost Fixed cost Variable cost (TC F
  VX) TC 1,600 0.90X

12
Regression Analysis
A statistical method used to create an equation
relating dependent (or Y) variables to
independent (or X) variables. Past data is used
to estimate relationships between costs and
activities.
Before doing the analysis, take time to determine
if a logical relationship between the variables
exists.
Independent variables are the cost drivers that
drive the variation in dependent variables.
13
Regression Analysis
The objective of the regression method is still
a linear equation to estimate costs TC F VX
TC value of the dependent variable, estimated
cost
F a fixed quantity, the intercept, that
represents the value of TC when X 0
V the unit variable cost, the coefficient of
the independent variable measuring the
increase in TC for each unit increase in X
X value of the independent variable, the cost
driver
14
Regression Analysis
A statistical procedure that finds the unique
line through data points that minimizes the sum
of squared distances from the data points to the
line.
400 350 300 250 200
Dependent Variable
50 100
150 200
Independent Variable
15
Regression Analysis
V the slope of the regression line or the
coefficient of the independent variable, the
increase in TC for each unit increase in X.
400 350 300 250 200
Dependent Variable
F a fixed quantity, the intercept
50 100
150 200
Independent Variable
16
Regression Analysis

• The correlation coefficient, r, is a measure of
  the linear relationship between variables such as
  cost and activity.

20










Total Cost
10
The correlation coefficient is highly positive
(close to 1.0) if the data points are close to
the regression line.
0
0 1 2 3 4
Activity
17
Regression Analysis

• The correlation coefficient, r, is a measure of
  the linear relationship between variables such as
  cost and activity.

20






Total Cost
10
The correlation coefficient is near zero if
little or no relationshipexists between the
variables.
0
0 1 2 3 4
Activity
18
Regression Analysis

• The correlation coefficient, r, is a measure of
  the linear relationship between variables such as
  cost and activity.

20








Total Cost
10
This relationship has a negative correlation
coefficient, approachinga maximum value of 1.0
0
0 1 2 3 4
Activity
19
Regression Analysis
R2, the coefficient of determination, is a
measureof the goodness of fit. R2 tells us the
amountof the variation of the dependent variable
thatis explained by the independent variable.
400 350 300 250 200
Dependent Variable
Regression withhigh R2 (close to 1.0)
50 100
150 200
Independent Variable
20
Regression Analysis
The coefficient ofdetermination, R2,is the
correlationcoefficient squared.
400 350 300 250 200
Dependent Variable
Regression withlow R2 (close to 0)
50 100
150 200
Independent Variable
21
Regression Analysis

• Uses all data points resulting in a better
  relationship between the variables.
• Generates statistical information that describes
  the relationship between variables.
• Permits the use of more than one cost driver
  activity to explain cost behavior.