1. Presented to Madam Ummara Sehar Presented by M.Asghar (St.# 2011-1031) M.Bilal Bashir (St.# 2011-1043)

2. Activity Analysis, Cost Behavior and Cost Estimation The relationship between cost estimation, cost behavior and cost prediction. Cost Estimation Cost Behavior Cost Prediction For managers to predict how costs will be affected by changes in an organization`s activity, they must understand the relation between these three categories and use a little magic. 3. Activity Analysis, Cost Behavior and Cost Estimation Cost BehaviorCost Estimation Cost Prediction The process of determining cost behavior. Often focuses on historical data The relationship between cost and activity Using knowledge of cost behavior to forecast at a particular level of activity. Focus is on the future 4. Types of costs Variable cost Fixed cost Step-variable cost Step-fixed cost Curvilinear cost 5. Cost In total Per unit Variable Total variable cost changes as activity level changes. Variable cost per unit remains the same over wide ranges of activity. Variable Cost 6. Semi-variable Costs There are certain costs which are partly fixed and partly variable. These can be described as semi- variable costs or semi-fixed cost. 7. Step-Variable Costs Step-Variable costs are nearly variable, but increase in small steps instead of continuously. 8. Cost In total Per unit Fixed Total fixed cost remains the same even when the activity level changes. Fixed cost per unit goes down as activity level goes up. Fixed Costs 9. Step-Fixed Costs Step-fixed costs remain fix over a wide range of activity but jump to a different amount for activity levels outside that range. 10. Curvilinear Costs Curvilinear costs are costs that vary with the volume of activity but not in constant proportion. 11. Relevant Range Relevant range is the range of activity over which the firm expects a set of cost behaviors to be consistent. 12. Engineered, committed, and discretionary Costs The distinction between engineered, committed, and discretionary costs. Engineered Cost Committed Cost Discretionary Cost In the process of budgeting costs, it is useful for management to make distinction between engineered, committed, and discretionary costs. 13. Committed CostEngineered Cost Discretionary cost An engineered cost bears a definitive physical relationship to the activity measure. A committed cost results from an organization`s ownership or use of facilities and its basic organization structure. A discretionary cost arises as a result of a management decision to spend a particular amount of money for some purpose. Engineered, committed, and discretionary Costs 14. Cost estimation is the process of determining how a particular cost behaves. Several methods (simple and sophisticated ) are commonly used to estimate the relationship between cost and activity. Cost Estimation 15. Methods Of Cost Estimation Account-Classification Method Least-Squares Regression Method Visual-Fit Method High-Low Method Engineering Method of Cost estimation 16. Review each account comprising the total cost being analyzed. Identify each cost as either fixed or variable. Account-Classification Method Estimate costs using account analysis Fixed Variable 17. A scatter diagram of past cost behavior may be helpful in analyzing mixed costs. Visual-Fit Method 18. Plot the data points on a graph (total cost vs. activity). 0 10 20 1 2 3 54 Visual-Fit Method 19. This is a method to estimate cost based on two cost observations, the highest and lowest activity level. High Low Change $12,883 $ 9,054 $ 3,829 568 200 368 Month Overhead costs Repair- hours 5 - 20 High-Low Method 20. Variable cost per unit (V) = (Cost at highest activity level Cost at lowest activity level) (Highest activity level Lowest activity level) 5 - 21 High-Low Method Variable cost per RH (V) = ($12,883 $9,054) 568 RH 200 RH = $3,829 368 RH = $10.40 per RH Now we can compute the total variable cost at either high or Low activity level. 21. 0 1 2 3 4 10 20 0 * * ** * * * ** * X Y High-Low Method Low activity level High activity level 22. This is a method to estimate cost based on two cost observations, the highest and lowest activity level. High Low Change $12,883 $ 9,054 $ 3,829 568 200 368 Month Overhead costs Repair- hours Least-Squares Regression Method 23. A method used to analyze mixed costs if a scattergraph plot reveals an approximately linear relationship between the X and Y variables. This method uses all of the data points to estimate the fixed and variable cost components of a mixed cost. The goal of this method is to fit a straight line to the data that minimizes the sum of the squared errors. Least-Squares Regression Method 24. Software can be used to fit a regression line through the data points. The cost analysis objective is the same: Y = a + bX Least-Squares Regression Method 25. 0 1 2 3 4 TotalCost 10 20 0 Activity * * ** * * * ** * X Y Least-Squares Regression Method 26. Cost estimates are based on measurement and pricing of the work involved Engineering Method of Cost estimation 27. Engineering Method of Cost estimation Direct Labor Direct Material Analyze the kind of work performed. Estimate the time required for each labor skill for each unit. Use local wage rates to obtain labor cost per unit. Material required for each unit is obtained from engineering drawings and specification sheets. Material prices are determined from vendor bids. 28. Regardless of method used, results will only be as good as the quality of the data used. Problems include Missing data Outliers Allocated and discretionary costs Inflation Mismatched time periods Trade-offs in choosing time period 29 LO 6 Data Collection Problems