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Hilton • Maher • Selto
11Cost Estimation
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
11-3
Concept of Cost Estimation
Relationship between activities and costs
Relationship between activities and costs
ActivitiesActivities
CostsCosts
3. This results in reduced . . .
1. Estimate . . .
We estimate costs to:
manage costsmake decisions
plan & set standards.
We estimate costs to:
manage costsmake decisions
plan & set standards.
2. Manage . . .
Exh.11-1
11-4
One Cost Driver and Fixed/Variable Cost Behavior
This model ignores other cost
behaviors and other cost drivers.
This model ignores other cost
behaviors and other cost drivers.
11-5
Intercept = Fixed Cost
Intercept = Fixed Cost
Slope = Cost Driver Rate
Slope = Cost Driver Rate
$.16
One Cost Driver and Fixed/Variable Cost Behavior
Exh.11-2
11-6
Multiple Cost Drivers and Complex Cost Behavior
In cases of complex cost behavior and
multiple cost drivers, the cost-benefit test
should be considered when developing a
cost estimation model.
In cases of complex cost behavior and
multiple cost drivers, the cost-benefit test
should be considered when developing a
cost estimation model.
11-7
Multiple Cost Drivers and Complex Cost Behavior
Step Cost•A cost that increases in steps as the amount of the cost driver volume increases.
•Also called a “semifixed cost”
Step Cost•A cost that increases in steps as the amount of the cost driver volume increases.
•Also called a “semifixed cost”
Costs stay fixed over a small range of activity
called the “relevant range”. As activity
increases to the next “relevant range,” costs
step up to the next level.
Costs stay fixed over a small range of activity
called the “relevant range”. As activity
increases to the next “relevant range,” costs
step up to the next level.
11-8
Multiple Cost Drivers and Complex Cost Behavior
Relevant Range
1 person can make 50 deliveries per day.
Anything more than 50 requires an additional
delivery person.
1 person can make 50 deliveries per day.
Anything more than 50 requires an additional
delivery person.
Exh.11-3
11-9
Semivariable Costs
A semivariable cost is one that has both
a fixed and a variable
component.
For example, a cellular phone plan that charges $40 for the first 60 minutes
and a per minute charge thereafter.
11-10
Nonlinear Costs
A nonlinear cost is one that has a
curved component.
For example, the cost of an item may
get increasingly cheaper as the
quantity purchased increases.
11-11
Learning Curve
A learning curve relates cost
behavior to the time it takes to learn a
job.
For example, the greater the
experience, the less labor hours are
required to complete the job.
A learning curve relates cost
behavior to the time it takes to learn a
job.
For example, the greater the
experience, the less labor hours are
required to complete the job.
11-12
Learning Curve
As evidenced by the learning curve,
the “learning phenomenon”
tends to disappear over time.
i.e. more learning occurs at the
beginning than at the end.
As evidenced by the learning curve,
the “learning phenomenon”
tends to disappear over time.
i.e. more learning occurs at the
beginning than at the end.
11-13
Cost Estimation MethodsRegression Analysis
A statistical method used to create an equation relating independent (or X)
variables to dependent (or Y) variables.
Past data is used to estimate relationships between costs and activities.
A statistical method used to create an equation relating independent (or X)
variables to dependent (or Y) variables.
Past data is used to estimate relationships between costs and activities.
Dependent variables are caused by the
independent variables.
Dependent variables are caused by the
independent variables.
Independent variables are the cost drivers that are correlated with the dependent variables.
Independent variables are the cost drivers that are correlated with the dependent variables.
11-14
Caution: Before doing the analysis, take time
to determine if a logical relationship
between the variables exists.
Caution: Before doing the analysis, take time
to determine if a logical relationship
between the variables exists.
Cost Estimation MethodsRegression Analysis
The simple cost model is actually a regression model:
TC = F + VX
The simple cost model is actually a regression model:
TC = F + VX
This model will only be useful within a relevant range of
activity.
This model will only be useful within a relevant range of
activity.
11-15
Cost Estimation MethodsRegression Analysis
A set of data can be regressed using several techniques:
•Manual computations•SPSS or SAS Statistical Software
•Excel or other spreadsheet
A set of data can be regressed using several techniques:
•Manual computations•SPSS or SAS Statistical Software
•Excel or other spreadsheet
The result of the regression process is a
regression model:
TC = F + VX
The result of the regression process is a
regression model:
TC = F + VX
Each regression model has an R-square (R2)
measure of how good the model is.
Range of R2 = 0 to 1.0
Each regression model has an R-square (R2)
measure of how good the model is.
Range of R2 = 0 to 1.0
11-16
Simple Regression AnalysisExample
CC Catering wants to know its average
fixed cost and variable cost per
unit.
Using the data to the right, let’s see
how to do a regression using
Excel.
CC Catering wants to know its average
fixed cost and variable cost per
unit.
Using the data to the right, let’s see
how to do a regression using
Excel.
11-17
Simple Regression AnalysisExample
You will need three pieces of information from your
regression analysis:
1. Estimated Variable Cost per Unit (line slope)
2. Estimated Fixed Costs (line intercept)
3. Goodness of fit, or R2
You will need three pieces of information from your
regression analysis:
1. Estimated Variable Cost per Unit (line slope)
2. Estimated Fixed Costs (line intercept)
3. Goodness of fit, or R2
To get these three pieces of information we will need to use THREE
different excel functions.
LINEST, INTERCEPT, & RSQ
To get these three pieces of information we will need to use THREE
different excel functions.
LINEST, INTERCEPT, & RSQ
11-18
Simple Regression Using Excel 2000
First, open the excel file
with your data and click on
“Insert” and “Function”
First, open the excel file
with your data and click on
“Insert” and “Function”
11-19
Simple Regression Using Excel 2000
When the function box opens, click
on “Statistical”,
then on “LINEST”
When the function box opens, click
on “Statistical”,
then on “LINEST”
11-20
Simple Regression Using Excel 2000
1. Enter the cell range for the cost amounts in the “Known_y’s” box.
2. Enter the cell range for the quantity amounts in the “Known_x’s” box.
1. Enter the cell range for the cost amounts in the “Known_y’s” box.
2. Enter the cell range for the quantity amounts in the “Known_x’s” box.
By clicking on the buttons to the left, you can highlight the desired cells
directly from the spreadsheet.
By clicking on the buttons to the left, you can highlight the desired cells
directly from the spreadsheet.
11-21
Simple Regression Using Excel 2000
The Slope, or estimated variable cost per unit, is identified here. Click OK to put this value on your
spreadsheet.
The Slope, or estimated variable cost per unit, is identified here. Click OK to put this value on your
spreadsheet.
11-22
Simple Regression Using Excel 2000
Repeat the procedure
using “Intercept”, to estimate fixed cost.
Repeat the procedure
using “Intercept”, to estimate fixed cost.
11-23
Simple Regression Using Excel 2000
As previously, enter the
appropriate cell ranges in their
appropriate places.
As previously, enter the
appropriate cell ranges in their
appropriate places.
The estimated fixed cost per unit is identified here.
The estimated fixed cost per unit is identified here.
11-24
Simple Regression Using Excel 2000
Finally, determine the “goodness of fit”, or R2, by
using the RSQ function.
Finally, determine the “goodness of fit”, or R2, by
using the RSQ function.
11-25
Simple Regression Using Excel 2000
As previously, enter the
appropriate cell ranges in their
appropriate places.
As previously, enter the
appropriate cell ranges in their
appropriate places.
The estimated R2 for your estimated cost function is identified here.
The estimated R2 for your estimated cost function is identified here.
11-26
Want an example?Want an
example?
For example, demand for a product may be
affected by things such as inflation, interest rates, and
competitors’ prices.
For example, demand for a product may be
affected by things such as inflation, interest rates, and
competitors’ prices.
Cost Estimation MethodsMultiple Regression Analysis
Multiple Regression is a regression that has more than one independent (X) variable.
Can be very useful in situations where the dependent variable is impacted by several
different independent variables.
Can be very useful in situations where the dependent variable is impacted by several
different independent variables.
11-27
Cost Estimation MethodsAccount Analysis
A method that looks at past costs to estimate current cost-driver
rates.
Break costs into categories corresponding to each cost driver.
Sum total costs for each cost driver category.
Divide total cost for a given cost driver category by cost driver volume.
A method that looks at past costs to estimate current cost-driver
rates.
Break costs into categories corresponding to each cost driver.
Sum total costs for each cost driver category.
Divide total cost for a given cost driver category by cost driver volume.
More expensive than
regression, and requires more detailed breakdown of
costs.
11-28
Cost Estimation MethodsData Problems
Missing Data
Outliers
Mismatched Time Periods
Allocated Costs
Inflation
11-29
Cost Estimation MethodsEngineering Method
Not based on
past costs.
Not based on
past costs.
Cost estimates based on measurement and pricing of the work
involved in the activities that go into a product.
Cost estimates based on measurement and pricing of the work
involved in the activities that go into a product.
11-30
Choosing an Estimation MethodThings to Consider
Regression and account
analysis rely on past data.
Engineering relies on
present data.
Regression and account
analysis rely on past data.
Engineering relies on
present data.
Each method will likely
yield a different estimate.
Each method will likely
yield a different estimate.
Cost/Benefit must be
considered in choosing a
method.
Cost/Benefit must be
considered in choosing a
method.
11-31
Choice of Estimation Method
11-32
I wonder if I have
regressed TOO far?
End of Chapter 11