December 8, 2011

Cost Behavior Analysis and Relevant Costs Concept

Cost behavior is identified by estimating cost functions. Cost function is mathematical relationship between cost and the level of an activity. Examples of activities used in cost accounting to develop cost functions are units of output, direct manufacturing labor hours, machine hours etc. A cost function can be depicted on a graph by showing activity level on the x-axis and cost on the y-axis.

Two basic assumptions are used in estimating cost functions.

1. Variations in the cost under consideration are explained by variations in the level of a single activity (Single activity is sufficient to capture the variation in the cost).
2. Cost behavior is adequately approximated by a linear function within the relevant range. (Even though the function is shown on the graph from zero to infinity, the decision maker knows that the graph is valid only between some range and not from zero to infinity).

Cost Estimation Procedures

1. Industrial Engineering Method
2. Conference Method
(W. Wichelll, Realistic cost Estimating for Manufacturing, 2nd ed., Society for Manufacturing Engineers, Dearborn, Michigan, 1989)
3. Account Analysis Method
4. Quantitative Analsis Method
a. High-Low Method
b. Regression Analysis

Learning Curves

Learning has an effect on efficiency and productivity. The effect was first identified and described in aircraft industry. As workers become more familiar with their tasks, their efficiency improves. Managers learn how to improve the allocation and scheduling of the work among available operators and machines. Some of the machines are provided facilitating devices like jigs and fixtures to increase production. As a result of improved efficiency, unit costs decrease as output increases. This effect is nonlinear and in cost estimating for future this effect needs to be considered.

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