MBA 649 Strategic Managerial Accounting & Control

Week 5

Chapter 6 Cost Behavior and Cost Estimation

Dr. Yijing Jiang

Department of Accountancy
 To understand costing in
Roadmap day-to-day production

Direct materials
Product Costs Direct labor
Overhead
1. Traditional, volume-based
2. Activity-based

Chapter 6: To understand cost behavior:

You have a factory in Montreal…
… and it’s been a success!
… and you want to open a second one in Toronto
… what would the costs be in Toronto?

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 Cost Behavior

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Cost Behavior

Cost
Cost Cost
Estimatio
Behavior Prediction
n

The process of The relationship between Using knowledge of cost

determining cost behavior. cost and activity. behavior to forecast the
Often focuses on historical level of cost at a particular
data. level of activity.
Focus on the future.

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Cost Behavior Patterns

Factory rent
Total cost
of chips

Number of iPhones Number of iPhones

produced produced

Variable costs Fixed costs

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Relevant Range
 Relevant range: The range of activity within which the assumption of
cost behaviors holds
 Some fixed costs become stepwise costs when production volume
exceeds the relevant range

Do variabl
e costs hav
relevant ra e
nge?

Cost
Activity
Stepwise costs

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 Cost Behavior Patterns
Total Cost

Curvilinear Cost

Relevant Range

Activity
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Cost Behavior Patterns Delivery-truck costs: a fixed-
cost component per month,
plus a variable component of
gas, maintenance, etc.
Total Lease Cost

Variable Lease
Charge Per Hour

Fixed Monthly
Rental Charge

Rental Charge Per Hour

Mixed Cost (or Semi-variable Cost)

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 Cost Estimation

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Cost Estimation
1. Account-classification method

2. Visual-fit method

3. High-low method

4. Regression method

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Account Classification Method
 Using judgement to classify each general ledger account as variable,
fixed, or mixed.

Direct materials Variable

Depreciation Fixed

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Visual-fit & High-low
 Using historical data.

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Visual-fit Method

20 * *
*
1,000’s of Dollars

* *
Total Cost in

*
* *
* *
10

0
0 1 2 3 4
Activity, 1,000’s of Units Produced
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High-low Method

20 * * Highest activity
*
1,000’s of Dollars

* *
Total Cost in

*
* *
* *
10
Lowest activity

0
0 1 2 3 4
Activity, 1,000’s of Units Produced
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Regression Method
 OLS – Ordinary Least Squares
 A statistical model that looks for the fitted line with the smallest sum of
squared errors

Learning Objectives:
Able to interpret and use regression results.

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Regression Method
 Ordinary Least Squares – how it works

20 point_i * *
*
* *
error_i *
* *
* *
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Sum(squared error) = error_1^2 +
error_2^2 + … + error_n^2

0 Find the line with the smallest sum(squared

0 1 2 3 error)4

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Regression Method – Model Specification
 Donut Desire’s utilities cost:
 The model: Y = a + bX
 Y: monthly utilities cost
 X: (cost driver) dozens of bakery
items sold per month
Y’s X’s

To determine the values of the

coefficients (a & b)

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Regression Method – Model Interpretation
 Donut Desire’s utilities cost:
 The model: Y = a + bX
 Y: monthly utilities cost
 X: (cost driver) dozens of bakery items sold per month
Utilities cost is $1,920 when
sales is 0. {FIXED COSTS}

How likely the result is BY

CHANCE;
Rule of thumb: p<=0.05

Utilities cost increases by

$0.049 with each additional
dozen of bakery sold.
{VARIABLE COSTS}

How well the data fit the model (goodness of fit);

Rule of thumb varies by field

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Multiple Regression Model Interpretation
 Donut Desire’s utilities cost:
 The model: Y = a + bX1 + cX2 + dX3
 Y: monthly utilities cost
 X1: dozens of bakery items sold per month
 X2: number of employees Holding other variables
constant, utilities cost
 X3: number of customers
increases by $0.041 with each
additional dozen of bakery
sold.

Based on the sample, we do

not find a statistically
significant association
between number of customers
and the utilities cost.

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Multiple Regression Model Interpretation
 Donut Desire’s production plan for October:
 Expected sales: 80,000 dozens of bakery items
 Expected number of employees: 500
 Expected number of customers: 300
 What is the predicted utilities cost for October?

1,820 + 80,000 x 0.041 + 500 x 11.259 + 300 x 8.579

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