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Cost Notes

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8 views3 pages

Cost Notes

Uploaded by

gazelleplays
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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1.

Importance of Understanding Cost


Behavior Risks in Cost Estimation
● Decision-making, planning, and ● Spurious Correlations: A strong
control require accurate cost statistical relationship might not
estimation. imply a true cause-and-effect link.
● Budgets, performance reports, and ● Economic Plausibility:
relevant costs rely on distinguishing ● Ensure the relationship makes
fixed costs and variable costs at logical sense.
various activity levels. ● Example: More component parts →
Higher material handling costs
Cost Drivers (logical cause-and-effect)..
● A cost driver is any factor causing a
change in total cost (e.g., labour 1. Engineering Method
hours, machine hours). 2. Inspection of Accounts Method
● Identifying the major cost driver is 3. Graphical/Scattergraph Method
crucial for cost estimation. 4. High-Low Method
5. Least-Squares Method
COST FUNCTION: Represents the
relationship between total costs (dependent 1. Engineering Method: Analyzes cost
variable) and cost drivers (independent behavior using engineering analysis (e.g.,
variables). work sampling, time and motion studies).
REGRESSION EQUATION: Used to ● Estimates input-output relationships
estimate this relationship. (materials, labour, machine time)
SIMPLE REGRESSION: One independent through direct observation.
variable; can be plotted as a straight line. ● Converts physical measures (e.g.,
MULTIPLE REGRESSION: Two or more hours, materials) into cost estimates
independent variables. by applying prices or rates.
● For Repetitive processes with clear
REGRESSION EQUATION FORMULA input-output relationships.
● Direct materials, direct labour,
machine hours.

2. Inspection of Accounts Method: A


departmental manager and accountant
inspect expense accounts for a specific
period.
Classify costs as:
● Fixed: Total cost remains constant
(e.g., £50,000).
● Variable: Cost per unit (e.g.,
£24.50/unit).
● Semi-Variable: Split into fixed and
variable components (e.g., £5,000
fixed + £0.50/unit).
● Use agreed cost functions to
estimate future costs.

Simplified Explanation of the Graphical


(Scatter Graph) Method:

1. Concept: Total costs are plotted on the


vertical axis (Y-axis).
Activity levels (e.g., machine hours) are
plotted on the horizontal axis (X-axis).
Simplified Explanation of the Least-Squares
● The point where the line intersects Method: Determines line of best fit for a set
the Y-axis represents the fixed cost of data points.
(non-variable cost). ● It minimizes the sum of the squares
● The slope of the line indicates the of vertical deviations (differences
variable cost per unit of activity. between actual data points and the
line).
4. Example:
1. Regression Line Formula: y = a + bx
a. Fixed cost (y-intercept)
b. Variable cost per unit (slope
of the line)

● y = a + bx
● Total cost= Fixed cost + (Variable
cost)(Total hours)
●
Simplified Explanation of the High-Low
Method: Only the highest and lowest activity
levels to estimate the cost function. N represents the number of observations or
data points in the dataset.
R^2 = 0.8861 means 88.61% of variation in
total cost is explained by the chosen cost
driver (e.g., machine hours).
The remaining 11.39% is due to random
variation or other unmeasured variables.
Higher R^2 → stronger relationship between
cost and activity.

3. Correlation Coefficient
The closer the actual data points are to the ● r measures the degree of
regression line, the stronger the relationship association between two variables:
between the activity level Positive r → as one variable increases, the
other increases (strong positive
Tests of Reliability relationship).
1. Plotting Data Negative r → as one variable increases, the
● Plot the data (e.g., cost vs. machine other decreases.
hours) and draw the **regression r = 0 → no correlation (random distribution
line of data).
● If data points are close to the line →
strong relationship.
● If widely scattered → weak or no
relationship.

2. Coefficient of Determination R^2


● R^2 measures how well the
independent variable (e.g., machine
hours) explains the variation in the
dependent variable (e.g., total cost).

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