1

Cost EstimationCost-Volume-Profit Analysis

Chapters 6 and 7

Learning Objectives Perform cost estimation methods (high-low and regression analysis) Understand and calculate break-even sales volume in total dollars and total units Understand contribution margin

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Cost Estimation

• Cost estimation is the development of a well-defined ___________________________________________ for the purpose of producing the cost

• It helps ________________ using previously identified activity-based, volume-based, structural, or executional cost drivers

• Cost estimation _________________________ for a cost object and which of these costs drivers are most useful in predicting cost

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Six Steps of Cost Estimation

1. Define the _________ for which the related costs are to be estimated

2. Determine the ____________

3. __________________________ on the cost object and the cost drivers

4. Graph the data

5. Select and employ an appropriate estimation method (__________ and __________________)

6. Evaluate the accuracy of the cost estimate

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High-Low Method

The high-low method uses two points to estimate the general cost equation

Y = F VX

Y = Total costF = Fixed costV = Variable cost per unitX = Cost driver activity in number of units

Basic Steps1. Select the highest and the lowest of activity level (X)2. Calculate variable cost per unit based on two selected

points3. Calculate fixed cost using Y = F VX

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Cost Estimation Example

ABC company has its own photocopying department. ABC’s photocopying costs include costs of copy machines, operators, paper, toner, utilities, and so on. We have the following cost and activity data

MonthNumber of

copies

Total Photocopying

Cost (baht)Month

Number of copies

Total Photocopying

Cost (baht)

1 16000 2500 7 14500 2360

2 19500 2900 8 21000 2800

3 15000 2400 9 19250 2750

4 15500 2300 10 14000 2350

5 20000 2800 11 17500 2600

6 14250 2350 12 20000 2750

Use the high-low method and regression method to measure cost behavior of the photocopy department

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Cost Estimation Example

0

500

1000

1500

2000

2500

3000

3500

0 5000 10000 15000 20000 25000

Number of Copies

Tot

al P

hoto

copy

ing

Cos

t (ba

ht)

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Regression Analysis

• Regression analysis is a statistical method for obtaining the unique cost estimating equation that best fits a set of data points

• The objective of the regression method is still a linear equation to estimate costs

Y = a + bX + ε

xbya

xnx

yxnxyb

22

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Regression Analysis

50 100 150 200

400

350

300

250

200

Outlier

Su

pp

lies

Exp

ense

Units

Outliers may be discarded toobtain a regression that is more

representative of the data.

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Evaluating Regression Analysis

Evaluating a Regression Analysis

R2, the coefficient of determination, is a measure of the explanatory power

of the regression, the degree thatchanges in the dependent

variable can be predicted by changesin the independent variable.

R2, the coefficient of determination, is a measure of the explanatory power

of the regression, the degree thatchanges in the dependent

variable can be predicted by changesin the independent variable.

The standard error of the estimate (SE) is a measureof the accuracy of the regression’s estimates.

The standard error of the estimate (SE) is a measureof the accuracy of the regression’s estimates.

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Cost-Volume-Profit for Breakeven Planning

• Effects of output volume on – Revenue (sales)– Expenses (costs)– Net income (net profit)

• Simplifying assumption: classify costs as either variable or fixed costs w.r.t. a single measure of output volume

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Break-Even Point

• Level of sales at which Revenue = Expenses, andNet Income = 0

• To asses possible risks: How far sales can fall below the planed level before losses occur, Margin of Safety

Margin of Safety = Planned Unit Sales – Break Even Unit Sales

• Contribution Margin Technique:Contribution margin = (unit sales price) – (unit variable cost)At BEP, (Total Contribution Margin) = (Total Fixed Cost)

• Equation Technique:At BEP, Net income = 0.(Sales) – (Variable Costs) – (Fixed Costs) = Net Income = 0

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BEP Example

Per Unit

Selling Price

Variable cost per unit

Selling Price less variable cost

Monthly fixed expenses

Rent

Wages

Other fixed expenses

Total fixed expenses per month

$0.50

0.40

0.10

$1000

4,500

500

$6000