Cost Estimation Methods

Summary of Four Cost Estimation Methods

Question: You are now able to create the cost equation Y = f + vX to estimate costs using four approaches. What does the cost equation look like for each approach at Bikes Unlimited?

Answer: The results of these four approaches for Bikes Unlimited are summarized as follows:

  • Account analysis: Y = $30,000 + $52.00X
  • High-low method: Y = $26,000 + $60.00X
  • Scattergraph method: Y = $45,000 + $52.86X
  • Regression analysis: Y = $43,276 + $53.42X


Question: We have seen that different methods yield different results, so which method should be used?

Answer: Regression analysis tends to be most accurate because it provides a cost equation that best fits the line to the data points. However, the goal of most companies is to get close – the results do not need to be perfect. Some could reasonably argue that the account analysis approach is best because it relies on the knowledge of those who are familiar with the costs involved.

At Bikes Unlimited, Eric (CFO) and Susan (cost accountant) met several days later. After consulting with her staff, Susan agreed that regression analysis was the best approach to use in estimating total production costs (keep in mind nothing has been done yet with selling and administrative expenses). Account analysis was ruled out because no one on the accounting staff had been with the company long enough to review the accounts and determine which costs were variable, fixed, or mixed. The high-low method was ruled out because it only uses two data points and Eric would prefer a more accurate estimate. Susan did request that her staff prepare a scattergraph and review it for any unusual data points before performing regression analysis. Based on the scattergraph prepared, all agreed that the data was relatively uniform and no outlying data points were identified.

Susan: My staff has been working hard to determine what will happen to profit if sales volume increases. So far, we've been able to identify cost behavior patterns for production costs, and we're currently working on the cost behavior patterns for selling and administrative expenses.
Eric: What do you have for production costs?
Susan: The portion of production costs that are fixed – that won't change with changes in production and sales – totals $43,276. The portion of production costs that are variable – that vary with changes in production and sales – totals $53.42 per unit.
Eric: When do you expect to have further information for the selling and administrative costs?
Susan: We should have those results by the end of the day tomorrow. At that point, I'll put together an income statement projecting profit for August.
Eric: Sounds good. Let's meet when you have the information ready.