Cost Estimation Methods

LEARNING OBJECTIVE

  1. Estimate costs using account analysis, the high-low method, the scattergraph method, and regression analysis.


Question: Recall the conversation that Eric (CFO) and Susan (cost accountant) had about Bikes Unlimited's budget for the next month, which is August. The company expects to increase sales by 10 to 20 percent, and Susan has been asked to estimate profit for August given this expected increase. Although examples of variable and fixed costs were provided in the previous sections, companies typically do not know exactly how much of their costs are fixed and how much are variable. (Financial accounting systems do not normally sort costs as fixed or variable.) Thus organizations must estimate their fixed and variable costs. What methods do organizations use to estimate fixed and variable costs?

Answer: Four common approaches are used to estimate fixed and variable costs:

  • Account analysis
  • High-low method
  • Scattergraph method
  • Regression analysis

All four methods are described next. The goal of each cost estimation method is to estimate fixed and variable costs and to describe this estimate in the form of Y = f + vX. That is, Total mixed cost = Total fixed cost + (Unit variable cost × Number of units). Note that the estimates presented next for Bikes Unlimited may differ from the dollar amounts used previously, which were for illustrative purposes only.