Cost Accounting Chapter 10

List the six steps in estimating a cost function on the basis of an analysis of a past cost relationship. Which step is typically the most difficult for the cost analyst?

1. Choose the dependent variable (the variable to be predicted, which is some type of cost). 2. Identify the independent variable or cost driver. 3. Collect data on the dependent variable and the cost driver. 4. Plot the data. 5. Estimate the cost function. 6. Evaluate the cost driver of the estimated cost function.

Describe three criteria for evaluating cost functions and choosing cost drivers.

1. Economic plausibility. 2. Goodness of fit. 3. Slope of the regression line.

Name 4 approaches to estimating a cost function

1. Industrial engineering method 2. Conference method 3. Account analysis method 4. Quantitive analysis of current or past cost relationships

Define learning curve. Outline two models that can be used when incorporating learning into the estimation of cost functions.

A learning curve is a function that measures how labor-hours per unit decline as units of production increase because workers are learning and becoming better at their jobs. Two models used to capture different forms of learning are 1. Cumulative average-time learning model. The cumulative average time per unit declines by a constant percentage each time the cumulative quantity of units produced doubles. 2. Incremental unit-time learning model. The incremental time needed to produce the last unit declines by a constant percentage each time the cumulative quantity of units produced doubles.

What is the difference between a linear and nonlinear cost function? Give an example of each type.

A linear cost function is a cost function where, within the relevant range, the graph of total costs versus the level of a single activity related to that cost is a straight line. An example of a linear cost function is a cost function for use of a videoconferencing line where the terms are a fixed charge of $10,000 per year plus a $2 per minute charge for line use. A nonlinear cost function is a cost function where, within the relevant range, the graph of total costs versus the level of a single activity related to that cost is not a straight line. Examples include economies of scale in advertising where an agency can double the number of advertisements for less than twice the costs, step-cost functions, and learning-curve-based costs.

Describe the account analysis method for estimating a cost function.

It estimates cost functions by classifying cost accounts in the subsidiary ledger as variable, fixed or mixed with respect to the identified level of activity. Typically, managers use qualitative, rather than quantitative, analysis when making these cost-classification decisions.

Discuss four frequently encountered problems when collecting cost data on variables included in a cost function. Frequently encountered problems when collecting cost data on variables included in a cost function are

1. The time period for measuring the dependent variable does not properly match the period for measuring the cost driver. 2. Fixed costs are allocated as if they are variable. 3. Data are either not available for all observations or are not uniformly reliable. 4. Extreme values of observations occur. 5. There is no homogeneous relationship between the individual cost items in the dependent variable-cost pool and the cost driver 6. The relationship between the cost and the cost driver is not stationary. 7. Inflation has affected costs, the cost driver, or both

Describe three alternative linear cost functions

1. Variable Cost Function: A cost function in which total costs change in proportion to the changes in the level of activity in the relevant range. 2. Fixed Cost Function: A cost function in which total costs do not change with the changes in the level of activity in the relevant range. 3. Mixed Cost Function: A cost function that has both variable and fixed elements. Total costs change but not in proportion to the changes in the level of activity in the relevant range.

What two assumptions are frequently made when estimating a cost function?

1. Variations in the level of a single activity (the cost driver) explain the variations in the related total cost 2. Cost behavior is approximated by a linear cost function within the relevant range. A linear cost function is a cost function where, within the relevant range, the graph of total costs versus the level of a single activity forms a straight line.

When using the high-low method, should you base the high and low observations on the dependent variable or the cost driver?

Causality in a cost function runs from the cost driver to the dependent variable. Thus, choosing the highest observation and the lowest observation of the cost driver is appropriate in the high-low method

"High correlation between two variables means that one is the cause and the other is the effect." - Do you agree? Explain.

No. High correlation merely indicates that the two variables move together in the data examined. It is essential also to consider economic plausibility before making inferences about cause and effect. Without any economic plausibility for a relationship, it is less likely that a high level of correlation observed in one set of data will be similarly found in other sets of data.

Describe the conference method for estimating a cost function. What are two advantages of this method?

The conference method estimates cost functions on the basis of analysis and opinions about costs and their drivers gathered from various departments of a company (purchasing, process engineering, manufacturing, employee relations, etc.). Advantages of the conference method include 1. The speed with which cost estimates can be developed. 2. The pooling of knowledge from experts across functional areas. 3. The improved credibility of the cost function to all personnel.