1. Cost behaviour, cost drivers and cost estimation3
Cost behaviour, cost drivers and cost estimation

2. Basic concepts Cost behaviour Cost estimation Cost prediction
The relationship between a cost and the level of activity or cost driver
Cost estimation
The process of determining the cost behaviour of a particular cost item
Cost prediction
Using knowledge of cost behaviour to focus the level of cost at a particular level of activity

4. Cost drivers A cost driver
An activity or factor that causes costs to be incurred
The higher the correlation between the cost and cost driver, the more accurate is the description and understanding of cost behaviours
Conventional understandings of cost behaviour regarded costs as variable or fixed, based on the level of production volume
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5. Cost drivers
Contemporary viewpoints recognise that there are a range of possible costs divers other than production volume (non-volume cost drivers)
Activity-based approaches classify costs and cost drivers into four levels:
Unit
Batch
Product, and
Facility
continued

6. Cost drivers Unit level costs Batch level costs
Relate to activities that are performed for each unit produced
Uses conventional volume-based cost drivers
Batch level costs
Relate to activities performed for a group of product units
Product (or product-sustaining) level
Relate to activities performed for specific products or product groups
Facility level
Costs incurred to run the business
continued

7. Cost drivers Selecting the best cost drivers Input or outputs?
An example of an input cost driver is the weight of material, and an output driver is the number of units of production
Cost benefit principles will determine the choice
How detailed should the analysis be?
Long or short term?
Cost behaviour and cost drivers can change over time
Depends on the purpose of the cost prediction
continued

8. Cost drivers Cost drivers for cost estimation or cost management?
Cost drivers that are used to predict costs, may differ from those used to manage costs
Effective cost management requires the identification of root cause cost drivers
The basic costs that cause a cost to be incurred
The true causes of costs
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9. Cost drivers
In choosing cost drivers the costs and benefits of each driver must be assessed:
Reasons for analysing cost behaviour
Timeframes for analysing the cost behaviour
Availability of data on cost drivers, and
Any other uses for the cost behaviour information

11. Cost behaviour patterns
Variable costs
Fixed costs
Step-fixed costs
Semi-variable costs
Curvilinear costs
continued

12. Cost behaviour patterns
Variable costs
Change in total in direct proportion to a change in activity
The variable cost is the slope of the cost line in the following cost function:
Y = a + bX
Where Y = total cost
a = fixed cost component (the intercept on the vertical axis)
b = variable cost per unit of activity (the slope of the line)
X = the level of activity
continued

14. Cost behaviour patterns
Fixed costs
Remains unchanged in total as the level of activity varies
As activity increases, total fixed costs do not change, but unit fixed cost declines
Contemporary approaches to cost analysis recognise that there are cost drivers for some of these “fixed” costs, and very few costs remain fixed
continued

16. Cost behaviour patterns
Step-fixed costs
Remain fixed over a wide range of activity levels but jump to a different amount for levels outside that range
Semi-variable cost
Has both fixed and variable components
Curvilinear cost
Has a curved cost line, but is often approximated as a semi-variable cost function
continued

17. Slides prepared by Kim Langfield-Smith
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

18. Slides prepared by Kim Langfield-Smith
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

19. Slides prepared by Kim Langfield-Smith
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

20. Cost behaviour patterns
Cost structures are shifting towards a decreasing proportion of costs that vary with production due to:
Labour being replaced by equipment, which does not vary with production output
Production wages moving towards fixed salaries that do not vary with production activity levels
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

21. Slides prepared by Kim Langfield-Smith
Cost estimation
Approaches to cost estimation
Managerial judgement
Engineering approach, and
Quantitative analysis
Using managerial judgment to estimate costs
The account classification method involves managers using their judgement to classify costs as exhibiting certain behaviours
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

22. Slides prepared by Kim Langfield-Smith
Cost estimation
The engineering approach to estimating costs
Studying processes that result in the incurrence of a cost
Focus on the relationships that should exist between inputs and outputs
Using time and motion studies (or task analysis) where employees are observed as they undertake work tasks
Activity-based approaches extend task analysis to the study of indirect activities and costs
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

23. Slides prepared by Kim Langfield-Smith
Cost estimation
Estimating costs using quantitative analysis
A scatter plot can be useful in allowing us to plot the data points to visualise the relationship between cost and the level of activity
The high-low method involves taking the two observations with the highest and lowest level of activity to calculate the cost function
Regression analysis is a statistical technique that uses all observations to determine the cost function
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

24. Slides prepared by Kim Langfield-Smith
Cost estimation
Regression analysis
Allows us to estimate the line of best fit by making the deviations between the cost line and the data points as small as possible
Simple regression involves estimating the relationship between the dependent variable (Y) and one independent variable (X)
Y = a + bX
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

25. Slides prepared by Kim Langfield-Smith
Cost estimation
Regression analysis
Multiple regression allows us to include two or more independent variables, that is, cost drivers
Y = a + b1X1 + b2X2
The regression line can be evaluated using several criteria:
Economic plausibility
Goodness of fit
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

26. Slides prepared by Kim Langfield-Smith
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

27. Practical issues in cost estimation
Data collection problems
Missing data
Outliers
Mismatched time periods for dependent and independent variables
Trade-offs in choosing the number of observations and the reliability of past data points as predictors of future cost behaviour
Allocated fixed costs
Inflation
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

28. Practical issues in cost estimation
Effect of learning on cost behaviour
In estimating labour costs for relatively new product or processes, labour times per unit may decrease at varying rates
Activity-based approaches allows us to consider more complex cost behaviour patterns
Costs are assigned to activities
Unit, batch and product level costs are assumed to vary in proportion to their cost drivers
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

29. Practical issues in cost estimation
The accuracy of cost functions
Sometimes approximate estimates are used to estimate cost functions within firms
Why is the case?
Limited time and knowledge to undertake quantitative techniques
The data required to estimate reliable cost functions may not exist
A low priority may be given to determining accurate cost behaviour and cost estimation
Subjective cost estimates may be considered good enough for the firm’s needs
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

30. Practical issues in cost estimation
All cost functions are based on simplifying assumptions, such as:
Cost behaviour depends on a single activity
Cost behaviours are linear within a relevant range
Costs and benefits of producing accurate cost information need to be assessed
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith