Cost Estimation Methods

Key Takeaways

  • Account analysis requires that a knowledgeable employee (or group of employees) determine whether costs are fixed, variable, or mixed. If employees do not have enough experience to accurately estimate these costs, another method should be used.
  • Table 5.1 "Variable Cost Behavior for Bikes Unlimited" and Figure 5.1 "Total Variable Production Costs for Bikes Unlimited" show that total variable costs change with changes in activity, but per unit variable cost does not change with changes in activity. Table 5.2 "Fixed Cost Behavior for Bikes Unlimited" and Figure 5.2 "Total Fixed Production Costs for Bikes Unlimited" show that total fixed costs do not change with changes in activity, but per unit fixed costs do change with changes in activity. Table 5.3 "Mixed Cost Behavior for Bikes Unlimited" and Figure 5.3 "Total Mixed Sales Compensation Costs for Bikes Unlimited" show that total mixed costs change with changes in activity, and per unit mixed cost also changes with changes in activity.
  • The high-low method starts with the highest and lowest activity levels and uses four steps to estimate fixed and variable costs.
  • The scattergraph method has five steps and starts with plotting all points on a graph and fitting a line through the points. This line represents costs throughout a range of activity levels and is used to estimate fixed and variable costs. The scattergraph is also used to identify any outlying or unusual data points.
  • Regression analysis forms a mathematically determined line that best fits the data points. Software packages like Excel are available to perform regression analysis. As with the account analysis, high-low, and scattergraph methods, this line is described in the equation form Y = f + vX. This equation is used to estimate future costs.
  • Four methods can be used to estimate fixed and variable costs. Each method has its advantages and disadvantages, and the choice of a method will depend on the situation at hand. Experienced employees may be able to effectively estimate fixed and variable costs by using the account analysis approach. If a quick estimate is needed, the high-low method may be appropriate. The scattergraph method helps with identifying any unusual data points, which can be thrown out when estimating costs. Finally, regression analysis can be run using computer software such as Excel and generally provides for more accurate cost estimates.