Q1. What is the most common error on the hi-lo method of estimation?

Q2. When would a regression analysis yield a better answer than hi-low method?

Q3. In 2022, the data set will include the years before and the years during the global pandemic. What will be harm for estimation for predictive behavior of using the information in this data set?

Determining

How Costs Behave

Level 1: Unreliable

Level 2: Informal

Level 3: Standardized

Level 4: Monitored

Level 5: Optimized

Unpredictable environment for

which controls have not been

designed or implemented.

i.e. Basic Quickbooks clients, do-it yourself

owners’ manual records, spreadsheet

accounting, high turnover in accounting

client

Controls are present but

inadequately documented and

largely dependent on manual

intervention.

There are no formal

communications or training

programs related to the controls.

Controls are in place and

documented, and employees

have received formal

communications about them.

Undetected deviations from

controls may occur.

Standardized controls are in

place and undergo periodic

testing to evaluate their design

and operation; test results are

communicated to

management. Limited use of

automated tools may support

controls.

An integrated internal controls

framework with real-time monitoring

by management is in place to

implement continuous improvement.

Automated processes and tools

support the controls and enable the

organization to quickly change the

controls as necessary.

Variable costs—costs that change in total in

relation to some chosen activity or output

Fixed costs—costs that do not change in total

in relation to some chosen activity or output

Mixed costs—costs that have both fixed and

variable components; also called semivariable

costs

A cost function is a mathematical

representation of how a cost changes with

changes in the level of an activity relating to

that cost.

Variations in the level of a single activity

(the cost driver) explain the variations in the

related total costs.

Cost behavior is approximated by a linear

cost function within the relevant range.

1.

2.

◦

Graphically, the total cost versus the level of a

single activity related to that cost is a straight

line within the relevant range.

Accounting

Statistics

Variable Cost

Slope

Fixed Cost

Intercept

Mixed Cost

Linear Cost Function

The independent

variable:

the cost driver

y = mx + b

The dependent

variable:

the cost that is

being predicted

The slope of

the line:

variable cost

per unit

l

The intercept:

fixed costs

1.

2.

3.

Choice of cost object—different objects may

result in different classification of the same

cost

Time horizon—the longer the period, the

more likely the cost will be variable

Relevant range—behavior is predictable only

within this band of activity

The most important issue in estimating a cost

function is determining whether a causeand-effect relationship exists between the

level of an activity and the costs related to

that level of activity.

A cause-and-effect relationship might arise

as a result of:

◦ A physical relationship between the level of activity

and costs

◦ A contractual agreement

◦ Knowledge of operations

Note: A high correlation (connection) between

activities and costs does not necessarily mean

causality.

1.

2.

3.

4.

Industrial engineering method

Conference method

Account analysis method

Quantitative analysis methods

1. High-low method

2. Regression analysis

Estimates cost functions by analyzing the

relationship between inputs and outputs in

physical terms

Includes time-and-motion studies

Very thorough and detailed, but also costly

and time-consuming

Also called the work-measurement method

Estimates cost functions on the basis of

analysis and opinions about costs and their

drivers gathered from various departments of

a company

Pools expert knowledge

Reliance on opinions still makes this method

subjective

Estimates cost functions by classifying

various cost accounts as variable, fixed, or

mixed with respect to the identified level of

activity

Is reasonably accurate, cost-effective, and

easy to use, but is subjective

Uses a formal mathematical method to fit

cost functions to past data observations

Advantage: results are objective

1.

2.

3.

4.

5.

6.

Choose the dependent variable (the cost to

be predicted).

Identify the independent variable or cost

driver.

Collect data on the dependent variable and

the cost driver.

Plot the data.

Estimate the cost function using the highlow method or regression analysis.

Evaluate the cost driver of the estimated

cost function.

Simplest method of quantitative analysis

Uses only the highest and lowest observed

values

1.

Calculate variable cost per unit of activity.

Variable

Cost per

Unit of Activity

=

{

Cost associated with

highest activity level

Cost associated with

lowest activity level

}

Highest activity level – Lowest activity level

2.

Calculate total fixed costs.

Total Cost from either the highest or lowest activity level

– (Variable Cost per unit of activity X Activity associated with above total cost)

Fixed Costs

3.

Summarize by writing a linear equation.

Y = Fixed Costs + ( Variable cost per unit of Activity * Activity )

Y = FC + (VCu * X)

Regression analysis is a statistical method

that measures the average amount of change

in the dependent variable associated with a

unit change in one or more independent

variables.

Simple—estimates the relationship between

the dependent variable and one independent

variable

Multiple—estimates the relationship between

the dependent variable and two or more

independent variables

Goodness of fit—indicates the strength of the

relationship between the cost driver and costs

Residual term—measures the distance

between actual cost and estimated cost for

each observation

1.

2.

3.

Economic plausibility

Goodness of fit

Significance of the independent variable

1.

2.

3.

4.

5.

Economies of scale

Quantity discounts

Step cost functions—resources increase in

“lot-sizes”, not individual units

Learning curves—labor hours consumed

decrease as workers learn their jobs and

become better at them

Experience curve —broader application of

learning curve that includes downstream

activities including marketing and

distribution

Cumulative average-time learning model—

cumulative average time per unit declines by

a constant percentage each time the

cumulative quantity of units produced

doubles

Incremental unit-time learning model—

incremental time needed to produce the last

unit declines by a constant percentage each

time the cumulative quantity of units

produced doubles

1.

2.

The database should contain numerous

reliably measured observations of the cost

driver and the costs.

In relation to the cost driver, the database

should consider many values spanning a

wide range.

The time period for measuring the dependent

variable does not match the period for

measuring the cost driver.

Fixed costs are allocated as if they are

variable.

Data are either not available for all

observations or are not uniformly reliable.

Extreme values of observations occur from

errors in recording costs.

There is no homogeneous relationship

between the cost driver and the individual

cost items in the dependent variable-cost

pool. A homogeneous relationship exists

when each activity whose costs are included

in the dependent variable has the same cost

driver.

The relationship between the cost driver and

the cost is not stationary.

Inflation has affected costs, the driver, or

both.

The price is based on these factors:

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