Managerial Accounting Chapter 4

Chapter 5
Managerial Accounting
Cost Estimation
Prepared by Diane Tanner
University of North Florida
Cost Estimation Methods
 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
1. Account analysis
2. Scattergraph
3. High-low
4. Linear regression
The Goal of Cost Estimation
Goal is to create a total cost equation
Total cost = Variable cost/unit * # of units + Total fixed cost
TC = VCx + TFC
Y = mx + b
Both equations
serve the same
TC = Y = total costs
TFC = b = total fixed costs = y-intercept
VC = m = variable cost per unit = slope of function
x = units produced/sold
Account Analysis Method
Used to estimate fixed and variable costs
Step 1: Classify costs as variable or fixed
 Separate the list of costs into two piles—fixed costs versus
variable costs
 Requires professional judgment
Step 2: Determine variable costs per unit
Total Variable Costs
Activity Level Achieved
Step 3: Determine total fixed costs
 Add the costs in the fixed cost pile from step 1
Cost function (equation) =
TC = VCx + TFC
Scattergraph Approach
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 ‘trend’ line
through the data points
Step 4: Determine where the line crosses the y-axis
i.e., y-intercept = total fixed costs
Step 5: Determine the slope (rise over run), i.e., variable cost
per unit
Step 6: Write the cost equation
If you have forgotten how to graph data points, this will help.
Source Grade 4 Math Lessons
High-Low Method
 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
• Variable cost = Line slope
• Total fixed costs = Y-intercept
High-Low Method
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
Step 3: Pick one point—either the high or low:
Plug the total cost and the activity of the point you
selected in the cost equation: TC = VCx + TFC
First select the high and low amounts from the
activity column. Then use the costs related to
those activity points.
High-Low Method Continued
Step 4: Substitute the number of activity units for
the data point chosen in step 3 for “x”
Step 5: Solve for fixed costs “TFC”
Step 6: Replace the VC with the variable cost per unit
you calculated and the TFC with the fixed costs you
calculated, into the following formula:
TC= VC x + TFC
Only two variables will be displayed in the formula: X
and TC. The other components: VC and TFC, should
be replaced by the respective amounts.
The End