Cost Estimation Cost-Volume-Profit Analysis

1. 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

2. 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

3. Six Steps of Cost Estimation • Define the _________ for which the related costs are to be estimated • Determine the ____________ • __________________________ on the cost object and the cost drivers • Graphthe data • Select and employ an appropriate estimation method (__________ and __________________) • Evaluate the accuracy of the cost estimate

4. High-Low Method The high-low method uses two points to estimate the general cost equation Y = F  VX Y = Total cost F = Fixed cost V = Variable cost per unit X = Cost driver activity in number of units • Basic Steps • Select the highest and the lowest of activity level (X) • Calculate variable cost per unit based on two selected points • Calculate fixed cost using Y = F  VX

5. 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 Use the high-low method and regression method to measure cost behavior of the photocopy department

6. Cost Estimation Example

7. 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

8. Outlier Regression Analysis 400 350 300 250 200 Supplies Expense Outliers may be discarded toobtain a regression that is morerepresentative of the data. 50 100 150 200 Units

9. Evaluating Regression Analysis Evaluating a Regression Analysis R2, the coefficient of determination, is a measure of the explanatory powerof the regression, the degree thatchanges in the dependentvariable 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.

10. 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

11. Break-Even Point • Level of sales at which Revenue = Expenses, and Net 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

12. BEP Example