CHAPTER 3: MEASUREMENT OF COST BEHAVIOUR pp'9299

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LECTURE 2

• CHAPTER 3 MEASUREMENT OF COST BEHAVIOUR pp.92-99

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Cost Functions

• Decision making, planning, and control activities
  of management accounting require accurate, useful
  estimates of future costs
• First step in estimating or predicting costs is
  cost measurement, measuring cost behaviour as a
  function of appropriate cost drivers
• Second step is to use these cost measures to
  estimate future costs at expected, future levels
  of cost-driver activity.

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Cost Function

• An algebraic equation
• Used by managers
• To describe the relationship between a cost and
  its cost driver(s)

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Mixed-cost Function

• Let
• Y Total cost
• F Fixed cost
• V Variable cost per unit
• X Cost-driver activity in number of units
• We can write the mixed-cost function as
• Y F VX
• The mixed-cost function has the familiar form of
  a straight line and is called a linear-cost
  function.
• Lets look at question 3-37 p.116

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Criteria for Choosing Functions

• Managers should apply two principles to obtain
  accurate and useful cost functions
• Plausibility and
• Reliability.

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Plausibility Reliability

• The cost function must be plausible or
  believable.
• In addition, a cost functions estimates of costs
  at levels of activity must reliably conform with
  actually observed costs.

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Choice of Cost DriversActivity Analysis

• How exactly do managers go about choosing
  reliable and plausible cost functions?

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Choice of Cost DriversActivity Analysis

• Cannot have a good cost function without knowing
  the right cost drivers
• Choosing a cost function starts with choosing
  cost drivers
• Managers use activity analysis to identify
  appropriate cost drivers and their effects on the
  costs of making a product or providing a service

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Choice of Cost DriversActivity Analysis

• Activity analysis is especially important for
  measuring and predicting costs for which cost
  drivers are not obvious
• Lets look at question 3-A2 p.111

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Cost Prediction

• Cost prediction applies cost measures to
  expected future activity levels to forecast
  future costs.

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Methods of Measuring Cost Functions

• Once managers for a firm have determined the most
  plausible drivers behind different costs, they
  can choose from a broad selection of methods of
  approximating cost functions, including
• Engineering analysis
• Account analysis
• High-low analysis
• Simple least-squares regression

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Engineering Analysis

• Engineering analysis entails a systematic review
  of materials, supplies, labour, support services
  and facilities needed for products and services.
• It measures cost behaviour according to what
  costs should be, not by what costs have been.

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Account Analysis

• The simplest method of account analysis selects a
  volume-related cost driver and classifies each
  account as a variable or fixed cost
• The cost analyst then looks at each cost account
  balance and estimates either the variable cost
  per unit of cost-driver activity or the periodic
  fixed cost.
• Lets look at question 3-36 p.116. What do you
  predict the cost to be if 8 computers were made
  next month?