1. Managerial Accounting
Chapter 5
Managerial Accounting
Cost Estimation
Prepared by Diane Tanner
University of North Florida
Copyright ©2015. University of North Florida. All rights reserved.

2. Cost Estimation Methods2
Used by managers to
Enable the creation of a cost function so that costs can be predicted at various activity levels
Useful when fixed and variable costs are grouped together
Four common methods
Account analysis
Scattergraph
High-low
Linear regression

3. The Goal of Cost Estimation3
The Goal of Cost Estimation
Goal is to create a total cost equation
Total cost = Variable cost/unit * # of units + Total fixed cost
TC = VCx + TFC
Y = mx + b
Where:
TC = Y = total costs
TFC = b = total fixed costs = y-intercept
VC = m = variable cost per unit = slope of function
x = units produced/sold
Both equations serve the same purpose

4. Account Analysis Method4
Account Analysis Method
Used to estimate fixed and variable costs
Step 1: Classify costs as variable or fixed
Separate the list of costs into two piles—fixed costs versus variable costs
Requires professional judgment
Step 2: Determine variable costs per unit
Total Variable Costs
Activity Level Achieved
Step 3: Determine total fixed costs
Add the costs in the fixed cost pile from step 1
Cost function (equation) =
TC = VCx + TFC

5. Scattergraph Approach5
Scattergraph Approach
Used to estimate fixed and variable costs to determine how costs and activity levels change
Step 1: Acquire cost information over activity levels
Step 2: Graph the data points
Step 3 : Eyeball a linear relationship and draw a ‘trend’ line through the data points
Step 4: Determine where the line crosses the y-axis
i.e., y-intercept = total fixed costs
Step 5: Determine the slope (rise over run), i.e., variable cost per unit
Step 6: Write the cost equation
If you have forgotten how to graph data points, this will help. .
Source Grade 4 Math Lessons

6. 6
High-Low Method
Used to estimate fixed and variable costs at various levels of activity
Uses two data points, the high and low levels of activity and their related total costs
Results:
Variable cost = Line slope
Total fixed costs = Y-intercept

7. High-Low Method Key Point:7
High-Low Method
Step 1: Select the high and low data activity points
Step 2: Subtract the smallest from the largest cost and the smallest from the largest activity and use the changes in the following formula
Change in Cost
Change in Activity
= Variable cost per unit
Step 3: Pick one point—either the high or low:
Plug the total cost and the activity of the point you selected in the cost equation: TC = VCx + TFC
Key Point:
First select the high and low amounts from the activity column. Then use the costs related to those activity points.

8. High-Low Method Continued8
High-Low Method Continued
Step 4: Substitute the number of activity units for the data point chosen in step 3 for “x”
Step 5: Solve for fixed costs “TFC”
Step 6: Replace the VC with the variable cost per unit you calculated and the TFC with the fixed costs you calculated, into the following formula:
TC= VC x + TFC
Only two variables will be displayed in the formula: X and TC. The other components: VC and TFC, should be replaced by the respective amounts.

9. The End