1 Cost Estimation Cost-Volume-Profit Analysis Chapters 6 and 7 Learning Objectives  Perform cost estimation methods (high-low and regression analysis)  Understand and calculate break- even sales volume in total dollars and total units  Understand contribution margin

2 Cost Estimation Cost estimation is the development of a well-defined ___________________________________________ for the purpose of producing the cost It helps ________________ using previously identified activity- based, volume-based, structural, or executional cost drivers Cost estimation _________________________ for a cost object and which of these costs drivers are most useful in predicting cost

3 Six Steps of Cost Estimation 1.Define the _________ for which the related costs are to be estimated 2.Determine the ____________ 3.__________________________ on the cost object and the cost drivers 4.Graph the data 5.Select and employ an appropriate estimation method (__________ and __________________) 6.Evaluate the accuracy of the cost estimate

4 High-Low Method The high-low method uses two points to estimate the general cost equation Y = F  VX Y = Total cost F = Fixed cost V = Variable cost per unit X = Cost driver activity in number of units Basic Steps 1. Select the highest and the lowest of activity level (X) 2. Calculate variable cost per unit based on two selected points 3. Calculate fixed cost using Y = F  VX

5 Cost Estimation Example ABC company has its own photocopying department. ABC’s photocopying costs include costs of copy machines, operators, paper, toner, utilities, and so on. We have the following cost and activity data Month Number of copies Total Photocopying Cost (baht) Month Number of copies Total Photocopying Cost (baht) Use the high-low method and regression method to measure cost behavior of the photocopy department

6 Cost Estimation Example

7 Regression Analysis Regression analysis is a statistical method for obtaining the unique cost estimating equation that best fits a set of data points The objective of the regression method is still a linear equation to estimate costs Y = a + bX + ε

8 Regression Analysis Outlier Supplies Expense Units Outliers may be discarded to obtain a regression that is more representative of the data.

9 Evaluating Regression Analysis Evaluating a Regression Analysis R 2, the coefficient of determination, is a measure of the explanatory power of the regression, the degree that changes in the dependent variable can be predicted by changes in the independent variable. The standard error of the estimate (SE) is a measure of the accuracy of the regression ’ s estimates.

10 Cost-Volume-Profit for Breakeven Planning Effects of output volume on –Revenue (sales) –Expenses (costs) –Net income (net profit) Simplifying assumption: classify costs as either variable or fixed costs w.r.t. a single measure of output volume

11 Break-Even Point Level of sales at which Revenue = Expenses, and Net Income = 0 To asses possible risks: How far sales can fall below the planed level before losses occur, Margin of Safety Margin of Safety = Planned Unit Sales – Break Even Unit Sales Contribution Margin Technique: Contribution margin = (unit sales price) – (unit variable cost) At BEP, (Total Contribution Margin) = (Total Fixed Cost) Equation Technique: At BEP, Net income = 0. (Sales) – (Variable Costs) – (Fixed Costs) = Net Income = 0

12 BEP Example Per Unit Selling Price Variable cost per unit Selling Price less variable cost Monthly fixed expenses Rent Wages Other fixed expenses Total fixed expenses per month $ $1000 4, $6000