cost estimation chapter 5 copyright © 2011 by the mcgraw-hill companies, inc. all rights...
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Cost Estimation
Chapter 5
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
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Basic Cost Behavior PatternsL.O. 1 Understand the reasons for estimating fixed and variable costs.
Costs
Fixed costs Variable costs
Total fixed costs do notchange proportionately
as activity changes.
Per unit fixed costschange inversely as
activity changes.
Total variable costschange proportionately
as activity changes.
Per unit variable costremain constant asactivity changes.
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Methods Used to EstimateCost Behavior
• Charlene, owner of Charlene’s Computer Care (3C),wants to estimate the cost of a new computerrepair center.
• Engineering estimates
• Account analysis
• Statistical methods
LO1
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Engineering Estimates
L.O. 2 Estimate costs using engineering estimates.
• Cost estimates are based on measuring andthen pricing the work involved in a task.
• Identify the activities involved:– Labor– Rent– Insurance
• Estimate the time and cost for each activity.
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Account Analysis
L.O. 3 Estimate costs using account analysis.
• Review each account comprisingthe total cost being analyzed.
• Identify each cost as either fixed or variable.
Fixed Variable
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Statistical Cost Estimation
L.O. 4 Estimate costs using statistical analysis.
• Analyze costs within a relevant range, which isthe limits within which a cost estimate may be valid.
• Relevant range for a projection is usually betweenthe upper and lower limits (bounds) of past activitylevels for which data is available.
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Hi-Low Cost Estimation
• This is a method to estimate cost based on two costobservations, the highest and lowest activity level.
High
Low
Change
$12,883
$ 9,054
$ 3,829
568
200
368
MonthOverhead
costsRepair-hours
LO4
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Hi-Low Cost Estimation
Variable cost per unit (V) =
Fixed cost (F) =
LO4
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Hi-Low Cost Estimation
Variable costper RH (V)
=($12,883 – $9,054)568 RH – 200 RH
=$3,829368 RH
=$10.40per RH
Fixed costs (F) = ($12,883 – ($10.40 × 568 RH) = $6,976
Fixed costs (F) = ($9,054 – ($10.40 × 200 RH) = $6,974
Roundingdifference
LO4
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Regression Analysis
• Regression is a statistical procedure todetermine the relation between variables.
• It helps managers determine how well theestimated regression equation describesthe relations between costs and activities.
LO4
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Interpreting Regression
L.O. 5 Interpret the results of regression output.
• Independent variable:– The X term, or predictor– The activity that predicts (causes)
the change in costs
• Activities:– Repair-hours
• Dependent variable:– The Y term– The dependent variable– The cost to be estimated
• Costs:– Overhead costs
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Practical Implementation Problems
L.O. 6 Identify potential problems with regression data.
• Effect of:– Nonlinear relations– Outliers– Spurious relations– Using data that do not fit the assumptions
of regression analysis
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Statistical Cost Estimation
L.O. 7 Evaluate the advantages and disadvantagesof alternative cost estimation methods.
• Reliance on historical data is relatively inexpensive.• Computational tools allow for more data to be used
than for non-statistical methods.
• Reliance on historical data may be the only readilyavailable, cost-effective basis for estimating costs.
• Analysts must be alert to cost-activity changes.
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Data Problems
• Missing data
• Outliers
• Allocated and discretionary costs
• Inflation
• Mismatched time periods
LO7
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Appendix A: Microsoft as a Tool
L.O. 8 (Appendix A) Use Microsoft Excelto perform a regression analysis.
• Many software programs exist to aid in performingregression analysis.
• Data is entered and the user then selects the data andtype of regression analysis to be generated.
• The analyst must be well schooled in regression in orderto determine the meaning of the output.
• In order to use Microsoft Excel, the Analysis Tool Pakmust be installed.
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Learning Phenomenon
• This is the systematic relationship betweenthe amount of experience in performing a taskand the time required to perform it.
First unitSecond unitFourth unitEighth unit
100.0 hours 80.0 hours 64.0 hours 51.2 hours
(assumed)80% × 100 hours80% × 80 hours80% × 64 hours
UnitTime toproduce
Calculationof time
• Impact: It causes the unit price to decreaseas production increases.
• This implies a nonlinear model.
L.O. 9 (Appendix B) Understand the mathematical relationshipdescribing the learning phenomenon.
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End of Chapter 5
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin