Prepared by Diane Tanner University of North Florida

1. Chapter 5 Cost Estimation Prepared by Diane Tanner University of North Florida

2. Used by managers to Enable the creation of a cost function so that Costs can be predicted at various activity levels Useful when fixed and variable costs are grouped together Four common methods Account analysis Scattergraph High-Low Linear regression Cost Estimation Methods 2

3. The Goal of Cost Estimation 3 Goal is to create a total cost equation TC = VCx + FC Y = mx + b Where: TC = Y = total costs FC = b = fixed costs = y-intercept VC = m = variable cost per unit = slope of function x = units produced/sold Both equations serve the same purpose

4. Used to estimate fixed and variable costs Step 1: Classify costs as variable or fixed Requires professional judgment Go through the list of costs and separate into two piles—fixed costs versus variable costs Step 2: Determine variable costs per unit Account Analysis Method 4 Total Costs Activity Level • Step 3: Determine fixed costs • Add the costs in the fixed cost group from step 1 Cost function (equation) = TC = VCx + FC

5. Used to estimate fixed and variable costs to determine how costs and activity levels change Step 1: Acquire cost information over activity levels Step 2: Graph the data points Step 3 : Eyeball a linear relationship and draw a line through the data points Step 4: Determine where the line crosses the x-axis i.e., y-intercept (Fixed costs) Step 5: Determine the slope (rise over run), i.e., variable cost per unit Step 6: Write the cost equation Scattergraph Approach 5 If you have forgotten how to graph data points, this will help. .http://www.studyzone.org/testprep/math4/d/linegraph4l.cfm Source www.studyzone.org  Grade 4 Math Lessons

6. Results: Variable cost = Line slope Fixed costs = Y-intercept High-Low Method 6 • Used to estimate fixed and variable costs at various levels of activity • Uses two data points, the high and low levels of activity and their related total costs

7. High-Low Method 7 First pick the high and low amounts from the activity column. Then pick the costs related to those activity points. Key Point: Step 1: Select the high and low data activity points Step 2: Subtract the smallest from the largest cost and the smallest from the largest activity and use the changes in the following formula Change in Cost Change in Activity = Variable cost per unit

8. High-Low Method Continued 8 Step 3: Pick one point—either the high or low: Substitute the total cost of the point you selected for “TC” in the equation: TC = VCx+ FC Step 4: Substitute the variable cost from step 2 into the formula for “VC” Slope Step 5: Substitute the number of activity units for the data point chosen in step 3 for “x”

9. High-Low Method Continued 9 Step 6: Solve for fixed costs “FC” Step 7: Replace the VC with the variable cost per unit you calculated and the FC with the fixed costs you calculated, into the following formula: TC= VC x + FC Only two variables will be displayed in the formula–X and TC. The other letters—VC and FC should be replaced by the respective amounts.

10. The End