Cost Estimation

Week 02 Topic 03

ACCT112: Management Accounting

Themin Suwardy, SMU 2005

Revision Question

Scent Ltd. produces and sells a wide range of

perfumes in specially designed bottles.
The bottle is an important feature of the
product.
Complete the table below by putting a to
indicate if the cost is a direct cost (i.e. Direct
Labour or Direct Material), a manufacturing
overhead cost or a period cost.

Slide 2

Questions & Answers (1)

Cost Item
Aroma compounds
essential to create the
fragrance
Water (about 0.1% of
the content of each
bottle of perfume)
Water for consumption
during office meetings
Perfume bottles
Wages for the
production workers

Direct

Slide 3

Indirect

Period

Questions & Answers (2)

Cost Item
Overtime premium for
production workers. OT
is due to increase in
general workload.

Direct

Idle time due to

machine breakdown
Salaries of the
production supervisors
Salaries of the sales
supervisors
Office rent
Slide 4

Indirect

Period

Questions & Answers (3)

Cost Item
Factory utilities
Depreciation: factory
Depreciation: Shop
Transportation-in costs
on materials purchased

Direct

Transportation-out costs
to customers
R&D to explore new
products

Slide 5

Indirect

Period

One more Review Question

What are the 4 Ethical

Standards of the Institute
of Management
Accountants?
Use only the one-word
heading to indicate each
standard.

(a)
(b)
(c)

(d)

Slide 6

Seminar Outline
1. Cost Behaviour
2. Methods of Estimation (Mixed Cost)
3. Graph
4. Regression
5. High-Low
6. Issues with Cost Estimation
Chapter 3
Slide 7

1.1 Purpose of estimating Cost Behaviour

Cost
behavior
Existing
relationship
between cost
and activity.

Cost
estimation

Cost
prediction

Process of estimating
relationship between
costs and cost driver
activities that cause
those costs.

Using results of cost

estimation to
forecast a level of
cost at a particular
activity. Focus
is on the future.

Total wages = $8 x
No. of working hours

If workers work 10 hr,

predicted wages = $80

E.g.
Cost: Hourly
wages = $8
Activity:
Working Hours

Slide 8

1.2 Common types of Cost Behaviour

TC

TC

TC

Output Qty

TC

TC

Output Qty

Output Qty

Output Qty

TC

Output Qty
Slide 9

Output Qty

Class Response (1): Give example(s) of:

1. Fixed Cost
2. Variable Cost

3. Step Cost

4. Mixed Cost

Slide 10

Class Response (2): Cost Behaviour

(1) How to change a Fixed (or Mixed) cost to a
Variable Cost?

(2) Is it better to have Fixed Cost or Variable

Cost?

Slide 11

1.3 Predicting a Mixed Cost

$Y = a + bX
where: Y =
a =
b =
X=

total mixed cost (e.g. Electricity cost)

total fixed cost (intercept of the Y-axis)
variable cost per unit (slope of the line)
level of activity (cost driver e.g. machine hours)

Total Mixed Cost

$Y

te
c
i
d
e
r
P

st
o
dC

Variable Cost per

machine hour
(slope b)
Fixed Monthly Charge

X
Activity (e.g. Machine Hours)
Slide 12

2.1 Methods of Estimating Mixed Costs

Quantitative Methods:

Ask / Observation:

1. Engineering: classifies costs 1.

based upon an industrial
engineers evaluation of
2.
production methods, and
material, labor and overhead 3.
requirements.

Graph
Regression
High-Low

2. Accounts Analysis: each

account is classified as either
variable or fixed based on the
analysts knowledge of how
the account behaves.
Pages 116-117

Pages 118-126
Slide 13

Historical data

A Common Case for the 3 Methods

Slide 14

3.1 Graphing Method

How?
Outlie
r

Y/X $30

@ $3,500
Slide 15

4.1 Regression Method - Using Excel (1)

Slide 16

4.2 Regression Method - Using Excel (2)

Just plug the data into Excel and
run the regression function

How?

Regression Statistics
Multiple R

0.956352

R Square

0.91461

Adjusted R Square

0.902411

Standard Error

1471.264

Observations

Fixed C.
Var. C. / unit

9
Coefficients

Intercept

3611.778

X Variable 1

32.89333
Slide 17

5.1 High-Low Method (1) - Common mistakes

Ignore
outlier

Highest Driver

Lowest
Driver

Cost
Slide 18

5.2 High-Low Method (2)

Cost Driver (Xaxis)

Low
High

Exclude
outlier
Slide 19

5.3 High-Low Method (3)

High
Low
Difference
Var. Costs

Unit
550
150
400
$11,350 / 400

Total Costs
$20,450
$ 9,100
$11,350
$28.375

Total Cost = Fixed Costs + Variable Costs

TC = FC + (28.375 x Driver Qty)
$20,450 = FC + (28.375 x 550)
Solving: FC = $4,843.75
Slide 20

Quick Check (1)

Slide 21

6.1 Issues with Estimation

1. Time Horizon

5. Non Linearity

2. Relevant Range

6. Inefficiencies

3. Driver(s)

7. Uncertainties

4. Step Costs

8. Externalities

And remember GIGO

Slide 22

Q&A

Slide 23

Reinforcement of High-Low Method

What
What do
do you
you have
have to
to check
check for
for before
before using
using any
any
method?
method?
Highest
Highest &
& Lowest
Lowest what?
what?

VC
VC per
per unit
unit =
= ??

FC
FC =
= ??

Why
Why bother
bother with
with High-Low?
High-Low?
Slide 24

Another Practice Question?

Gluttons-In-Common (GIC) organizes monthly gourmet buffet gatherings

known as Consumption Functions. The following table gives the pertinent
information on the most recent functions.
How
How much
much must
must
GIC
GIC charge
charge each
each
person
person to
to just
just
break
break even
even if
if
only
only 25
25 persons
persons
signed
signed up
up for
for
the
the gourmet
gourmet
buffet
buffet in
in Jan-X2?
Jan-X2?
(Roundup to
the nearest $)

Date
Apr-X1
May-X1
Jun-X1
Jul-X1
Aug-X1
Sep-X1
Oct-X1
Nov-X1
Dec-X1

Slide 25

Attendance
37
31
19
29
57
61
51
23
43

Total Costs
$22,450
$19,870
$16,410
$19,010
$31,050
$31,110
$28,470
$16,430
$25,030

Answer

Slide 26

Example of Exam/Test Question for Topic 03

2014-15-T1 - Test 1 - Qn 3

Slide 27