Chapter 3- Cost estimation

Question 1

Why do cost estimation?

Answer 1

1. To manage costs
2. To make strategic and operational decisions
3. To plan and set standards

Question 2

Cost patterns

Answer 2

• step cost
• mixed costs
• non-linear cost behavior

Question 3

Step costs

Answer 3

Increases as the cost-driver volume increases

Question 4

Mixed costs

Answer 4

A fixed and variable component

Question 5

Non-linear cost behavior

Answer 5

Costs can also be curved

Question 6

Cost estimation methods

Answer 6

• account analysis
• linear regression analysis
• high-low method
• multiple regression analysis
• engineering estimates

Question 7

Account analysis method

Answer 7

Cost estimates are based on a review of each activity account making up the total cost being analyzed.

Objective: Relate costs and activity in the form of the general cost equation:

TC= F + VX

Question 8

Linear regression analysis

Answer 8

A statistical method used to create an equation relating dependent (or Y) variables to independent (or X) variables.Data from the past are used to estimate relationships between costs and activities.

• Independent variables are the cost drivers that drive the variation in dependent variables.
• Before doing the analysis, take time to determine if a logical relationship between the variables exists.

Question 9

High-low method

Answer 9

The high-low method uses two data points to estimate the general cost equation
TC = F + VX

• the two points should be representative of the cost and activity relationship over the range of af activity for which the estimation is made

Question 10

Multiple regression analysis

Answer 10

A regression that has more than one independent (X) variable,

Can be very useful insinuations where the dependent variable is impacted by several different independent variables.

–> for example, demand for a product may be affected by factors such as inflation, interest rates and competitors´prices

Question 11

Multiple regression analysis- caution

Answer 11

Often encountered problems when collecting data:

• insufficient data
• inconsistent data
• missing data
• outliers
• allocated and discretionary costs
• inflation
• mismatched time periods

Question 12

Engineering estimates

Answer 12

Engineering estimates of cost are made, based on:
* Measurement of work involved in the activities that go into a product.
* Assigning a cost to each of the activities- past costs are not taken into account

Question 13

Engineering method- advantages

Answer 13

1. Detailed analysis results in better knowledge of the entire process
2. The method is used to estimate costs of new activities. Data from prior activities are not required.

Question 14

Engineering method- disadvantages

Answer 14

The high cost of detailed analysis

Question 15

Choice of estimation method

Answer 15

No single method is best for all situations:

• regression and account analysis rely on past data
• engineering method relies on present data
• engineering and account analysis may lead to the establishment of logical, causal relationships between variables
• a scattergraph plot will lead to a better understanding of the relationship and may reveal outlier data points
• regression provides a cost equation for the data points with statistical measures of fit