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Chapter 5 Cost Estimation Methods

# Chapter 5 Cost Estimation Methods - Chapter 5 Cost...

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Chapter 5 Cost Estimation Cost Estimation Methods Mixed costs have a fixed portion and a variable portion. There are a handful of methods used by managers to break these costs in the two manageable components--fixed costs and variable costs. The process of breaking mixed costs into fixed and variable portions allow us to us the costs to predict and plan for the future since we know have a good insight on how these costs behave at various activity levels. We often call the process of separating mixed costs into fixed and variable components, cost estimation. This chapter covers three of the four most common methods of cost estimation: Account analysis Scatter graphs High-low method Regression The Goal of Cost Estimation The ultimate goal of cost estimation is to determine the amount of fixed and variable costs so that a cost equation can be used to predict future costs. You should remember the concept of functions from your business calculus class. The function that represents the equation of a line will appear in the format of: y = m x + b where y = total cost m = the slope of the line, i.e., the unit variable cost x = the number of units of activity b = the y-intercept, i.e., the total fixed costs Determining a linear function is useful in predicting cost amounts at different levels of activity. Why do managers need to be able to predict costs? They want to plan for future operations often through what- if analysis and budgets. A key concept you must remember is that before you employ any of the estimation methods, you must have already determined the cost is mixed. There is no need to analyze a cost to break it down into fixed and variable portions if you already know whether it is variable or fixed. Your goal it to determine the variable cost per unit and total fixed costs to plug into the cost equation. Helpful Hint: Note that the determination of 'cost per unit' is literal. When you read this label, write the equation exactly how it reads: Cost is on the numerator' Per means divide; and units appears on the denominator. Account Analysis

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Chapter 5 Cost Estimation Methods - Chapter 5 Cost...

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