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CHAPTER 10
DETERMINING HOW COSTS BEHAVE
101
The two assumptions are:
1.
Variations in the total costs of a cost object are explained by variations in a single cost driver.
2.
A linear cost function adequately approximates cost behavior within the relevant range of the
cost driver.
A linear cost function is a cost function where, within the relevant range, the
graph of total costs versus a single cost driver forms a straight line.
102
Three alternative linear cost functions are:
1.
Variable cost function––a cost function in which total costs change in proportion to the
changes in the level of activity in the relevant range.
2.
Fixed cost function––a cost function in which total costs do not change with changes in the
level of activity in the relevant range.
3.
Mixed cost function––a cost function that has both variable and fixed elements.
Total costs
change but not in proportion to the changes in the level of activity in the relevant range.
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A linear cost function is a cost function where, within the relevant range, the graph of
total costs versus the level of a single activity is a straight line.
An example of a linear cost function
is a cost function for use of a telephone line where the terms are a fixed charge of $10,000 per year
plus a $2 per minute charge for phone use.
A nonlinear cost function is a cost function where,
within the relevant range, the graph of total costs versus the level of a single activity is not a
straight line.
Examples include economies of scale in advertising where an agency can double the
number of advertisements for less than twice the costs, stepfunction costs, and learningcurve
based costs.
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No.
High correlation merely indicates that the two variables move together in the data
examined.
It is essential to also consider economic plausibility before making inferences about
cause and effect.
Without any economic plausibility for a relationship, it is less likely that a high
level of correlation observed in one set of data will be similarly found in other sets of data.
105
Four approaches to estimating a cost function are:
1.
Industrial engineering method.
2.
Conference method.
3.
Account analysis method.
4.
Quantitative analysis of current or past cost relationships.
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The conference method develops cost estimates on the basis of analysis and opinions
gathered from various departments of an organization (purchasing, process engineering,
manufacturing, employee relations, etc.).
Advantages of the conference method include:
1.
The speed with which cost estimates can be developed.
2.
The pooling of knowledge from experts across functional areas.
3.
The improved credibility of the cost function to all personnel.
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107
The account analysis method estimates cost functions by classifying cost accounts in the
ledger as variable, fixed, or mixed with respect to the identified level of activity.
Typically,
managers use qualitative, rather than quantitative, analysis when making these costclassification
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 Spring '11
 anyofthem
 Regression Analysis, Cost driver

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