Cost Estimation Cost-Volume-Profit Analysis

Chapters 6 and 7

Learning Objectives

 (high-low and regression analysis)   Perform cost estimation methods Understand and calculate break even sales volume in total dollars and total units Understand contribution margin 1

Cost Estimation

• • • Cost estimation is the development of a well-defined ___________________________________________ purpose of producing the cost for the 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 2

Six Steps of Cost Estimation

1. Define the _________ to be estimated for which the related costs are 2. Determine the ____________ 3. __________________________ on the cost object and the cost drivers 4. Graph the data 5. Select and employ an appropriate estimation method ( __________ and __________________ ) 6. Evaluate the accuracy of the cost estimate 3

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 1.

Select the highest and the lowest of activity level (

X

) 2.

Calculate variable cost per unit based on two selected 3.

points Calculate fixed cost using

Y = F



VX

4

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 Month Number of copies Total Photocopying Cost (baht) Month Number of copies Total Photocopying Cost (baht) 1 2 16000 19500 2500 2900 7 8 14500 21000 2360 2800 3 4 5 6 15000 15500 20000 14250 2400 2300 2800 2350 9 10 11 12 19250 14000 17500 20000 2750 2350 2600 2750 Use the high-low method and regression method to measure cost behavior of the photocopy department 5

Cost Estimation Example

3500 3000 2500 2000 1500 1000 500 0 0 5000 10000 15000 Number of Copies 20000 25000 6

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

b

 

xy



n x y



x

2 

n x

2

a



y



b x

7

Regression Analysis

400 350 300 250 200

Outlier Outliers may be discarded to obtain a regression that is more representative of the data.

50 100 150 200

Units

8

Evaluating Regression Analysis

Evaluating a Regression Analysis

R 2

, the coefficient of determination, is a measure of the explanatory power of the regression, the degree that changes in the dependent variable can be predicted by changes in the independent variable.

The standard error of the estimate (SE) is a measure of the accuracy of the regression ’ s estimates.

9

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 10

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 11

BEP Example

Selling Price Variable cost per unit Selling Price less variable cost

Monthly fixed expenses

Rent Wages Other fixed expenses Total fixed expenses per month Per Unit $0.50

0.40

0.10

$1000 4,500 500 $6000 12