# ACCT102- Midterm 2 Cheat Sheet - Session 10 Cost Estimation...

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Session 10: Cost Estimation Purpose: identify causal relationship between a cost (cost pool) and its driver(s) One way to characterize relationship: Cost function Assumption: cost function can be represented reasonably accurately as a linear relationship btw cost and its driver(s) over some relevant range of activity Single cost driver Cost = a+bX (a= FC, b=VC/unit of cost driver, X) For given cost, its behavior depends on: Range of activity (data available & operations of firm are stable) AND Time horizon (generally all costs Var in LR) 4 Methods to estimate a cost function—we focus on quantitative methods To make valid predictions, need to establish a cause-and-effect relationship exists High-low method - Good: easy, need only 2 data points (high & low of cost driver) Bad: sensitive to data used, does not use all data available (diff in actual & pred.) VC = Cost/ Cost driver, Constant = Cost – VC(cost driver ex. MH) Linear Regression - Good: uses all available data- likely more accurate, little cost C = a+bX+E (E=random factors), higher R 2 better fit, smaller p-value better Session 11: Activity Based Costing (ABC) Systems Problems w/ conventional costing : accumulated into small # cost pools likely misallocation (generally under-cost low vol products, over-cost high vol prods) Will conv. system misallocate OH costs (using one OH pool)? Case 1: produce 1 product, use 1 cost pool No risk Case 2: produce 2 substantially diff prods, low OH some risk - low econ conseq. Case 3: produce 2 substantially diff prods, high OH like 2 but more econ conseq. Conv. costing- Rate = OH costs/Alloc Rate (ex. DL cost/unit x # units produced) Results in alloc of costs that do not rep underlying diffs in way resources used ABC Costing: ID (OH) costs caused by purposeful activities more cost pools Good: use non-unit causal drivers, deal w/ physical volume prob, see econ of prod process, non-value added activites & prod design efficient, avoidable/non costs Bad: costly, some alloc arbitrary- assumes lin relationships btw ID costs & drivers Hierarchy of costs - 1) unit-level 2) batch-level 3) prod-sustaining 4) facility-sustaining –variable fixed, more accurate when firm uses large quantities (costs) of indir. Resources & there is substantial diversity in firm’s products, etc. Question: worth it to implement before investment (costly)? Regression analysis a) Calculate OH alloc rate for each activity based cost pools (TC/Total driver used) b) Calc OH costs alloc to each amplifier (ex. # set-ups x set-up rate), + for total OH c) Calc total cost per unit of each type of amplifier (ex. DM + DL + OH) Session 12: Customer/Product Line Profitability Analysis - App of ABC Better see factors driving costs- not all customers equally profitable (20-225 rule) SG&A Costs = selling, advertising, etc. (GAAP=non-inventoriable period costs) 1) Pricing: to take SG&A into account, firms mark-up product costs –Bad assump ↓ Price/unit = Mark-up % x Product cost/unit