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©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Successor Group
Umair Ahmed 0042 Umair Abbas 0031Shahid Anwar 0034Ali Mardan 0017
Muneeb Ahsan 0022
University of central Punjab(Okara Campus)
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Determining How Costs Behave
Explain the two assumptions
frequently used in cost-behavior
estimation.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Assumptions in Cost-Behavior Estimation
Changes in total costs can be explained bychanges in the level of a single activity.
Cost behavior can adequately beapproximated by a linear function of theactivity level within the relevant range.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Functions And Common Ways
Describe linear cost functions and
three common ways in which they
behave.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Function
What is a cost function?
It is a mathematical expressiondescribing how costs change
with changes in the levelof an activity.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Function
La Playa Hotel offers an airlinethree alternative cost structures toaccommodate its crew overnight:
1. $60 per night per room usage
y = $60x
The slope of the cost function is $60.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Function
$0
$5,000
$10,000
$15,000
$20,000
0 100 200 300
x = Number of rooms
y =
Co
st
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Function
2. $8,000 per month
y = $8,000
$8,000 is called a constant or intercept.
The slope of the cost function is zero.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Function
$0
$5,000
$10,000
$15,000
$20,000
0 100 200 300
x = Number of rooms
y =
Co
st
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Function
3. $3,000 per month plus $24 per room
This is an example of a mixed cost.
y = $3,000 + $24x
y = a + bx
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Function
$0
$5,000
$10,000
$15,000
$20,000
0 100 200 300
x = Number of rooms
y =
Co
st
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Classification and Estimation Function
Choice of cost object
Time span
Relevant range
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Choice of Cost Object Example
If the number of taxis owned by a taxi companyis the cost object, annual taxi registration andlicense fees would be variable costs.
If miles driven during a year on a particular taxiis the cost object, registration and license feesfor that taxi are fixed costs.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Time Span
Whether a cost is variable or fixed with respect to a particular activity depends on the time span.
More costs are variable with longer time spans.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Relevant Range
Variable and fixed cost behavior patterns are valid for linear cost functions only within the given relevant range.
Costs may behave nonlinear outside the range.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Estimation
What is cost estimation?
It is the attempt to measure a pastcost relationship between costs
and the level of an activity.
Past cost-behavior functions can helpmanagers make more accurate
cost predictions.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Estimation Approaches
Industrial engineering method
Conference method
Account analysis method
Quantitative analysis methods
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Account Analysis Example
The cost analyst uses experience andjudgment to separate total costs into
fixed and variable.
Avisha & Co. sells software programs.
Total sales = $390,000
The company sold 1,000 programs.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Account Analysis Example
Cost of goods sold = $130,000
Manager’s salary = $60,000
Secretary’s salary = $29,000
Commissions = 12% of sales
What is the total fixed cost?
$60,000 + $29,000 = $89,000
What is the fixed cost per unit sold?
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Account Analysis Example
$89,000 ÷ 1,000 = $89.00
What is the variable cost per unit sold?
Cost of goods sold: $130,000
Commissions: $390,000 × .12 = $46,800
($130,000 + $46,800) ÷ 1,000 = $176.80
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Steps In Estimating A Cost Function
Six steps in estimatinga cost function on the basisof past cost relationships.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Steps In Estimating A Cost Function
Step 1:Choose the dependent variable.
Step 2:Identify the independent variable cost
driver(s).Step 3:
Collect data on the dependent variableand the cost driver(s).
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Steps In Estimating A Cost Function
Step 4: Plot the data.
Step 5: Estimate the cost function.
Step 6: Evaluate the estimated cost function.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
High-Low Method Example
High capacity December: 55,000 machine-hours
Cost of electricity: $80,450
Low capacity September: 30,000 machine-hours
Cost of electricity: $64,200
What is the variable rate?
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
High-Low Method Example
($80,450 – $64,200) ÷ (55,000 – 30,000)
$16,250 ÷ 25,000 = $0.65
What is the fixed cost?
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
High-Low Method Example
$80,450 = Fixed cost + (55,000 × $0.65)
Fixed cost = $80,450 – $35,750 = $44,700
$64,200 = Fixed cost + (30,000 × $0.65)
Fixed cost = $64,200 – $19,500 = $44,700
y = a + bx
y = $44,700 + ($0.65 × Machine-hours)
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Regression Analysis
It is used to measure the average amount of change in a dependent variable, such as electricity, that is associated with unit increases in the amounts of one or more independent variables, such as machine-hours.
Regression analysis uses all availabledata to estimate the cost function.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Regression Analysis
Simple regression analysis estimates therelationship between the dependentvariable and one independent variable.
Multiple regression analysis estimates therelationship between the dependent variable and multiple independent variables.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Regression Analysis
The regression equation and regression lineare derived using the least-squares technique
The objective of least-squares is to developestimates of the parameters a and b.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Regression Analysis
The regression method is more accurate thanthe high-low method.
The vertical difference (residual term) measuresthe distance between the actual cost and theestimated cost for each observation.