University:
Grand Rapids Community College
Course:
Financial and Managerial Accounting: Information for Decisions - John J. Wild
Academic year:

2024
Views:

307

Pages:

2
Author:

stud_ice13

Estimating costs is essential for cost-volume-profit (CVP) analysis, helping managers predict how costs behave as production levels change. Here are the three primary methods used to estimate fixed and variable costs: 1. Scatter Diagram • • • Definition: A scatter diagram is a graph of historical cost data where each point represents a combination of unit volume and total cost. Process: Managers plot the data and visually draw a line that best fits through the points. The line indicates the estimated relationship between cost and unit volume. For mixed costs, the line starts above zero and slopes upward, reflecting both fixed and variable components. Pros and Cons: This method provides a quick visual of cost behavior and works well for preliminary estimates, though it can be subjective without software tools for precision. 2. High-Low Method • • • Definition: The high-low method estimates cost behavior using only the highest and lowest activity levels. Steps: 1. Identify the highest and lowest activity volumes and their associated costs. 2. Compute the variable cost per unit (slope) using the formula: Variable cost per unit=Cost at high volume−Cost at low volume Compute total fixed costs by subtracting the total variable cost from the total cost at either the high or low volume. Example: If the lowest production volume is 1,600 units with a cost of $9,800, and the highest volume is 4,000 units with a cost of $17,000: o Variable cost per unit = 17,000−9,8004,000−1,600=3.13 o Using the high volume to calculate fixed costs: Fixed cost=17,000−(3.13×4,000)=$4,480 o Cost Equation: Total Cost=4,480+(3.13×Units) 3. Regression (Least-Squares Regression) • Definition: Regression analysis is a statistical method that calculates the best-fit line for cost data, providing a precise estimate of fixed and variable costs. • • • Process: Software tools like Excel calculate the line’s intercept (fixed cost) and slope (variable cost per unit) by minimizing the sum of squared deviations. Example: For the data provided in Exhibit 18.4, regression analysis yields a cost equation of: o Cost Equation: Total Cost=16,688+(0.20×Units) Pros and Cons: Regression is the most accurate method due to its comprehensive use of all data points, though it requires statistical tools and is more complex to apply. Comparing the Methods: • • • Scatter Diagram: Best for a quick visual estimate. High-Low Method: Easy to apply and useful for quick estimates but less precise due to limited data. Regression: Provides the most accurate estimates by using all data points, though it is more complex. Each method has value depending on the situation, balancing ease of use and precision requirements.