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Cost EstimationCost-Volume-Profit Analysis
Chapters 6 and 7
Learning Objectives Perform cost estimation methods (high-low and regression analysis) Understand and calculate break-even sales volume in total dollars and total units Understand contribution margin
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Cost Estimation
• Cost estimation is the development of a well-defined ___________________________________________ for the purpose of producing the cost
• It helps ________________ using previously identified activity-based, volume-based, structural, or executional cost drivers
• Cost estimation _________________________ for a cost object and which of these costs drivers are most useful in predicting cost
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Six Steps of Cost Estimation
1. Define the _________ for which the related costs are to be estimated
2. Determine the ____________
3. __________________________ on the cost object and the cost drivers
4. Graph the data
5. Select and employ an appropriate estimation method (__________ and __________________)
6. Evaluate the accuracy of the cost estimate
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High-Low Method
The high-low method uses two points to estimate the general cost equation
Y = F VX
Y = Total costF = Fixed costV = Variable cost per unitX = Cost driver activity in number of units
Basic Steps1. Select the highest and the lowest of activity level (X)2. Calculate variable cost per unit based on two selected
points3. Calculate fixed cost using Y = F VX
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Cost Estimation Example
ABC company has its own photocopying department. ABC’s photocopying costs include costs of copy machines, operators, paper, toner, utilities, and so on. We have the following cost and activity data
MonthNumber of
copies
Total Photocopying
Cost (baht)Month
Number of copies
Total Photocopying
Cost (baht)
1 16000 2500 7 14500 2360
2 19500 2900 8 21000 2800
3 15000 2400 9 19250 2750
4 15500 2300 10 14000 2350
5 20000 2800 11 17500 2600
6 14250 2350 12 20000 2750
Use the high-low method and regression method to measure cost behavior of the photocopy department
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Cost Estimation Example
0
500
1000
1500
2000
2500
3000
3500
0 5000 10000 15000 20000 25000
Number of Copies
Tot
al P
hoto
copy
ing
Cos
t (ba
ht)
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Regression Analysis
• Regression analysis is a statistical method for obtaining the unique cost estimating equation that best fits a set of data points
• The objective of the regression method is still a linear equation to estimate costs
Y = a + bX + ε
xbya
xnx
yxnxyb
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Regression Analysis
50 100 150 200
400
350
300
250
200
Outlier
Su
pp
lies
Exp
ense
Units
Outliers may be discarded toobtain a regression that is more
representative of the data.
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Evaluating Regression Analysis
Evaluating a Regression Analysis
R2, the coefficient of determination, is a measure of the explanatory power
of the regression, the degree thatchanges in the dependent
variable can be predicted by changesin the independent variable.
R2, the coefficient of determination, is a measure of the explanatory power
of the regression, the degree thatchanges in the dependent
variable can be predicted by changesin the independent variable.
The standard error of the estimate (SE) is a measureof the accuracy of the regression’s estimates.
The standard error of the estimate (SE) is a measureof the accuracy of the regression’s estimates.
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Cost-Volume-Profit for Breakeven Planning
• Effects of output volume on – Revenue (sales)– Expenses (costs)– Net income (net profit)
• Simplifying assumption: classify costs as either variable or fixed costs w.r.t. a single measure of output volume
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Break-Even Point
• Level of sales at which Revenue = Expenses, andNet Income = 0
• To asses possible risks: How far sales can fall below the planed level before losses occur, Margin of Safety
Margin of Safety = Planned Unit Sales – Break Even Unit Sales
• Contribution Margin Technique:Contribution margin = (unit sales price) – (unit variable cost)At BEP, (Total Contribution Margin) = (Total Fixed Cost)
• Equation Technique:At BEP, Net income = 0.(Sales) – (Variable Costs) – (Fixed Costs) = Net Income = 0
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BEP Example
Per Unit
Selling Price
Variable cost per unit
Selling Price less variable cost
Monthly fixed expenses
Rent
Wages
Other fixed expenses
Total fixed expenses per month
$0.50
0.40
0.10
$1000
4,500
500
$6000