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DSS-ESTIMATING COSTS. Cost prediction. Cost estimation. Introduction. Cost behavior. Existing relationship between cost and activity. Process of estimating relationship between costs and cost driver activities that cause those costs. - PowerPoint PPT Presentation
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The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin
DSS-ESTIMATING COSTS
The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin
11-2
Costprediction
Using results ofcost estimation
to forecast alevel of cost at
a particularactivity. Focusis on the future.
Existingrelationship
betweencost andactivity.
Process ofestimating relationship
between costsand cost driveractivities that
cause those costs.
Costestimation
Costbehavior
Introduction
The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin
11-3
Management needsto know the costs that
are likely to beincurred for each
alternative.
How muchwill costs increaseif sales increase
10 percent?
What will mycosts be if I introducethe new model in a
foreign market?
Reasons for Estimating Costs
The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin
11-4
BetterDecisionsAdd Value
AccurateCost
Estimates
ImprovedDecisionMaking
Reasons for Estimating Costs
The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin
11-5
Relationship between activities and costs
Relationship between activities and costs
ActivitiesActivities
CostsCosts
3. To reduce these
1. First, identify this
We estimate costs to:
manage costsmake decisions
plan & set standards
We estimate costs to:
manage costsmake decisions
plan & set standards
2. Then manage these
Exh.11-1
Reasons for Estimating Costs
The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin
11-6
Intercept = Fixed Cost
Intercept = Fixed Cost
Slope = Cost Driver Rate
Slope = Cost Driver Rate
$.16
One Cost Driver and Fixed/Variable Cost Behavior
Exh.11-2
The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin
11-7
CurvilinearCost Function
Relevant Range
Activity
To
tal
Co
stCurvilinear
Cost Function
A straight-Line(constant unit variable
cost) often closely approximates a
nonlinear line withinthe relevant range.
Nonlinear Costs
The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin
11-8
The high-low method uses two points to estimate the general cost equation TC = F VX
TC = the value of the estimated total cost
F = a fixed quantity that represents the value of Y when X = zero
V = the slope of the line, the unit variable cost .
X = units of the cost driver activity.
The High-Low Method
The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin
11-9
0 1 2 3 4
10
20
0
****
**
**
*
*
The high-low method uses two points to estimate the general
cost equation TC = F + VX
The two points should be representative ofthe cost and activity relationship over the range
of activity for which the estimation is made.
Activity, 1,000s of Units Produced
To
tal
Co
st i
n1,
000s
of
Do
llar
s
The High-Low Method
The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin
11-10
WiseCo recorded the following production activity and maintenance costs for two months:
Using these two levels of activity, compute: the variable cost per unit; the fixed cost; and then express the costs in equation form TC = F + VX.
Units Cost
High activity level 9,000 9,700$Low activity level 5,000 6,100 Change 4,000 3,600$
The High-Low Method
The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin
11-11
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 + $0.90X
Units Cost
High activity level 9,000 9,700$Low activity level 5,000 6,100 Change 4,000 3,600$
The High-Low Method
The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin
11-12
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.
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.
Independent variables are the cost drivers that
drive the variation in dependent variables.
Independent variables are the cost drivers that
drive the variation in dependent variables.
Before doing the analysis, take time to determine if a logical
relationship between the variables exists.
Before doing the analysis, take time to determine if a logical
relationship between the variables exists.
The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin
11-13
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
Regression Analysis
The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin
11-14
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.
50 100 150 200
400
350
300
250
200
De
pen
de
nt
Va
ria
ble
Independent Variable
Regression Analysis
The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin
11-15
50 100 150 200
400
350
300
250
200
De
pen
de
nt
Va
ria
ble
Independent Variable
V = the slope of the regression line or the coefficient of the independent variable, the increase in TC for each unit increase in X.
F = a fixed quantity, the intercept
Regression Analysis
The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin
11-16
The correlation coefficient, r, is a measure of the linear relationship between variables such as cost and activity.
0 1 2 3 4
To
tal
Co
st
10
20
0
***
**
****
Activity
*
The correlation coefficient is highly positive (close to 1.0) if the data points
are close to the regression line.
Regression Analysis
The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin
11-17
0 1 2 3 4
To
tal
Co
st
10
20
0
Activity
*
*
*
*
*
*
**
* *
The correlation coefficient is near zero if little or no relationshipexists between the variables.
The correlation coefficient, r, is a measure of the linear relationship between variables such as cost and activity.
Regression Analysis
The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin
11-18
0 1 2 3 4
To
tal
Co
st
10
20
0
Activity
*
*
*
** *
***
*This relationship has a negative
correlation coefficient, approachinga maximum value of –1.0
The correlation coefficient, r, is a measure of the linear relationship between variables such as cost and activity.
Regression Analysis
The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin
11-19
50 100 150 200
400
350
300
250
200
Regression withhigh R2 (close to 1.0)
De
pen
de
nt
Va
ria
ble
Independent Variable
R2, the coefficient of determination, is a measureof the goodness of fit. R2 tells us the amount
of the variation of the dependent variable thatis explained by the independent variable.
Regression Analysis
The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin
11-20
Regression withlow R2 (close to 0)
50 100 150 200
400
350
300
250
200
De
pen
de
nt
Va
ria
ble
Independent Variable
The coefficient ofdetermination, R2,is the correlation
coefficient squared.
Regression Analysis
The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin
11-21
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.
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.
Regression Analysis
