Chapter 10 – Determining How Costs Behave
I.
General Issues in Estimating Cost Functions
a.
Cost Function:
i.
Mathematical description of how a cost changes with changes in the level
of an activity relating to that cost
1.
Preparing setups for production runs, operating machines, etc
b.
Basic Assumptions and Examples of Cost Functions:
i.
Two assumptions:
1.
Variations in the level of a single activity (the cost driver) explain the
variations in the related total cost
2.
Cost behavior is approximated by a linear cost function within the
relevant range
a.
Relevant range:
i.
Range of the activity in which there is a relationship between
total cost and the level of activity
ii.
Slope Coefficient:
1.
Amount by which total cost changes when a oneunit change occurs in
the level of activity
iii. Constant:
1.
Fixed cost of an equation
a.
Also the yintercept
iv. Linear Cost Function:
1.
y = a + bX
c.
Brief Review of Cost Classification:
i.
Three Criteria for Classifying a Cost into its Variable and Fixed
Components:
1.
Choice of Cost Object:
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a.
A particular cost item could be variable with respect to one cost
object and fixed with respect to another cost object
2.
Time Horizon:
a.
Whether a cost is variable or fixed with respect to a particular
activity depends on the time horizon being considered
i.
Longer the time, more likely its variable
3.
Relevant Range:
a.
Managers should never forget that variable and fixed costbehavior
patterns are valid for linear cost functions only within the given
relevant range
II.
The CauseandEffect Criterion in Choosing Cost Drivers
a.
Most important issue in estimating a cost function is determining whether a
causeandeffect relationship exists between the level of an activity and the
costs related to that level of activity
i.
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 Spring '08
 Staff
 Management, Regression Analysis

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