MANAGEMENT
AND COST
ACCOUNTING
SIXTH EDITION
COLIN DRURY
Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8
© 2004 Colin Drury
Part Six:
The application of quantitative methods to management
accounting
Chapter Twenty-four:
Cost estimation and behaviour
Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8
© 2000 Colin Drury
© 2004 Colin Drury
24.1a
General principles
•
A regression equation (or cost function) measures past relationships
between a dependent variable (total cost)and potential independent
variables (i.e.cost drivers/activity measures).
•
Simple regression y = a + bx
Where y = Total cost
a = Total fixed cost for the period
b = Average unit variable cost
x = Volume of activity or cost driver for the period
•
Multiple regression y = a + b1 x1 + b2 x2
•
Resulting cost functions must make sense and be economically
plausible.
Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8
© 2000 Colin Drury
© 2004 Colin Drury
24.1b
Cost estimation methods
1. Engineering methods
2. Inspection of accounts method
3. Graphical or scattergraph method
4. High-low method
5. Least squares method.
Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8
© 2000 Colin Drury
© 2004 Colin Drury
24.2
Engineering methods
•
Analysis based on direct observations of physical quantities required for an
activity and then converted into cost estimates.
•
Useful for estimating the costs of repetitive processes where input-output
relationships are clearly defined.
•
Appropriate for estimating the costs associated with direct labour, materials
and machine time.
Inspection of accounts
•
Departmental manager and accountant inspect each item of expenditure
within the accounts for a particular period and classify each item as fixed,
variable or semi-variable.
Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8
© 2000 Colin Drury
© 2004 Colin Drury
24.3
Graphical or scattergraph method
• Past observations are plotted on a graph and a line of best fit is drawn.
• Unit VC = Difference in cost = £720 – £560
Difference in activity 240 hours – 160 hours
=
£2 per hour
• Y = £240 + £2x
Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8
© 2000 Colin Drury
© 2004 Colin Drury
24.4a
High – low method
•
Involves selecting the periods of highest and lowest activity levels and
comparing changes in costs that result from the two levels.
Example
Lowest activity
5,000 units
£22,000
Highest activity
10,000 units
£32,000
Cost per unit = £10,000/5,000 units = £2 per unit
Fixed costs = £22,000 – (5,000 × £2) = £12,000
•
Major limitation = Reliance on two extreme observations
Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8
© 2000 Colin Drury
© 2004 Colin Drury
24.4b
Figure 24.2 High – low method.
Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8
© 2000 Colin Drury
© 2004 Colin Drury
24.5a
The least squares method
Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8
© 2000 Colin Drury
© 2004 Colin Drury
24.5b
Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8
© 2000 Colin Drury
© 2004 Colin Drury
24.6a
Multiple regression analysis
Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8
© 2000 Colin Drury
© 2004 Colin Drury
24.6b
Multiple regression analysis contd.
Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8
© 2000 Colin Drury
© 2004 Colin Drury
24.7
Factors to be considered when using past data to estimate
cost functions
•
Identify the potential activity bases (i.e. cost drivers)
1. The objective is to find the cost driver that has the greatest effect on cost.
•
Ensure that the cost data and activity measures relate to the same period.
•
Some costs lag behind the associated activity measures (e.g.wages paid for the
output of a previous period).
•
Ensure that a sufficient number of observations are obtained.
•
Ensure that accounting policies do not lead to distorted cost functions.
•
Adjust for past changes so that all data relates to the circumstances of the planning
horizon.
•
Adjust for inflation,technological changes and observations based on abnormal
situations.
Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8
© 2000 Colin Drury
© 2004 Colin Drury
24.8
Summary
1. Select the dependent variable (y)
to be predicted.
2. Select the potential cost drivers.
3. Plot the observations on a
graph.*
4. Estimate the cost function.
5.Test the reliability of the cost
function.
*Be aware of the dangers of predicting
costs outside the relevant range.
Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8
© 2000 Colin Drury
© 2004 Colin Drury
24.9
Tests of reliability
1.
Coefficient of determination (r²)
 See Exhibits 24A.1 (page 1059) and 24A.2 (page 1059) for the calculation of
r² of 0.8861.
 r² of 0.8861 indicates that 88.61% of the variation in total cost is explained by
variations in the activity base and the remaining 11.39% is explained by either
random variation or the effect of other (omitted)variables on total cost.
2.
Standard error of the estimate
 Gives an indication of the absolute size of the probable deviations from the
line.
 For example, in Exhibit 24A.1 on page 1059 there is a 0.90 probability that
the true cost for an activity of 180 hours will fall within the range:
£2 400  1.812 (201.25) = £2 035 to £2 765
3.
Standard error of the coefficient
 Focuses on the regression coefficient b (i.e. variable cost)
 In Exhibit 24A.1 there is a 0.90 probability that the true variable cost lies
within the range £7.95 to £12.05.
Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8
© 2000 Colin Drury
© 2004 Colin Drury
24.10a
Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8
© 2000 Colin Drury
© 2004 Colin Drury
24.10b
Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8
© 2000 Colin Drury
© 2004 Colin Drury
24.11a
Mathematical method
Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8
© 2000 Colin Drury
© 2004 Colin Drury
24.11b
Mathematical method contd.
Management and Cost Accounting, 6th edition, ISBN 1-84480-028-8
© 2000 Colin Drury
© 2004 Colin Drury