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D. Ph. Inc. Rooney. Ph..D. Ph. CIA Cynthia J. CPA Charles W.Cost Estimation Chapter 5 PowerPoint Authors: Susan Coomer Galbreath. CMA Jon A.B. .D.. Caldwell.A. CPA. Booker. CPA McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies.. All rights reserved..D.

Per unit fixed costs change inversely as activity changes.LO 5-1 Basic Cost Behavior Patterns LO 5-1 Understand the reasons for estimating fixed and variable co Costs Fixed costs Variable costs Total fixed costs do not change proportionately as activity changes. Per unit variable cost remain constant as activity changes. Total variable costs change proportionately as activity changes. 5-3 .

LO 5-2 Engineering Estimates LO 5-2 Estimate costs using engineering estimates. Identify the activities involved: – Labor – Rent – Insurance Estimate the time and cost for each activity. Cost estimates are based on measuring and then pricing the work involved in a task. 5-4 .

Fixed Variable 5-5 . Review each account comprising the total cost being analyzed.LO 5-3 Account Analysis LO 5-3 Estimate costs using account analysis. Identify each cost as either fixed or variable.

Analyze costs within a relevant range. 5-6 .LO 5-4 Statistical Cost Estimation LO 5-4 Estimate costs using statistical analysis. which is the limits within which a cost estimate may be valid. Relevant range for a projection is usually between the upper and lower limits (bounds) of past activity levels for which data is available.

LO 5-4 Scattergraph We use “eyeball judgment” to determine the intercept and slope of the line. 5-7 .

LO 5-4 Hi-Low Cost Estimation Variable cost per unit (V) = Fixed cost (F) = Total cost at – (Variable cost × Lowest activity level) lowest activity 5-8 .

Independent variable: – The X term.LO 5-5 Interpreting Regression LO 5-5 Interpret the results of regression output. or predictor – The activity that predicts (causes) the change in costs Activities: – Repair-hours Dependent variable: – The Y term – The dependent variable – The cost to be estimated Costs: – Overhead costs 5-9 .

0 the closer the points are to the regression line.LO 5-5 Interpreting Regression Correlation coefficient (R): This measures the linear relationship between variables. The closer R is to zero. the poorer the fit of the regression line. 5-10 . It is the proportion of the variation in the dependent variable (Y) explained by the independent variable(s) (X). Coefficient of determination (R2): This is the square of the correlation coefficient. The closer R is to 1.

LO 5-6 Practical Implementation Problems LO 5-6 Identify potential problems with regression data. Effect of: – Nonlinear relations – Outliers – Spurious relations – Using data that do not fit the assumptions of regression analysis 5-11 .

Practical Implementation Problems The Effect of Nonlinear Relations $800 Assumed actual cost function $700 $600 Cost LO 5-6 $500 Regression estimate $400 $300 Relevant range $200 Capacity $100 $0 0 5 10 15 20 25 30 35 40 Volume 5-12 .

LO 5-6 Practical Implementation Problems The Effect of Outliers on the Computed Regression Computed regression line “Outlier” True regression line 5-13 .

5-14 .LO 5-6 Practical Implementation Problems The Effect of Spurious Relations Problem: Using too many variables in the regression (i. Although the association is very high. Solution: Carefully analyze each variable and determine the relationship among all elements before using in the regression. using direct labor to explain materials costs).e. actually both are driven by output..

then the regression is not reliable.LO 5-6 Practical Implementation Problems The Effect of Using Data That Do Not Fit the Assumptions of Regression Problem: If the assumptions in the regression are not satisfied. Limit time to help assure costs behavior remains constant. yet this causes the model to be weaker due to less data. Solution: There is no clear solution. 5-15 .

• Reliance on historical data may be the only readily available. 5-16 . cost-effective basis for estimating costs. • Analysts must be alert to cost-activity changes.LO 5-7 How an Estimation Method is Chosen LO 5-7 Evaluate the advantages and disadvantages of alternative cost estimation methods. • Computational tools allow for more data to be used than for non-statistical methods. • Reliance on historical data is relatively inexpensive.

Data is entered and the user then selects the data and type of regression analysis to be generated.LO 5-8 Appendix A: Regression Analysis Using Microsoft Excel LO 5-8 (Appendix A) Use Microsoft Excel to perform a regression analysis. the Analysis Tool Pak must be installed. 5-17 . The analyst must be well schooled in regression in order to determine the meaning of the output. In order to use Microsoft Excel. Many software programs exist to aid in performing regression analysis.

• This implies a nonlinear model. This is the systematic relationship between the amount of experience in performing a task and the time required to perform it.LO 5-9 Appendix B: Learning Curves LO 5-9 (Appendix B) Understand the mathematical relationship describing the learning phenomenon.0 hours 80. 5-18 . Unit First unit Second unit Fourth unit Eighth unit Time to produce 100.0 hours 64.2 hours Calculation of time (assumed) 80% × 100 hours 80% × 80 hours 80% × 64 hours • Impact: It causes the unit price to decrease as production increases.0 hours 51.

End of Chapter 5 5-19 .