Chapter 10

Determining How Costs Behave

Cost Function

A mathematical description of how a cost changes with changes in the level of an activity relating to that cost.

General Issues in Estimating Cost Functions

[Basic Assumptions] 

1.Variations in the level of a single activity (the cost driver) explain the variations in the related cost.

2. Cost behavior is approximated by a linear function within the relevant range. 

Brief Review of Cost Classification

Choice of Cost Object

Time Horizon

Relevant Range 

Cost Estimation & Prediction 

Estimation: Think Past

Prediction: Think Future

Cause-and-Effect Criterion for Choosing Cost Drivers 

1. A physical Relationship between the level of activity and costs

2. A contractual arrangement

3. Knowledge of Operations 

Estimating a Cost Function Using Quantitative Analysis

1. Choose a Dependent Variable

 2. Identify the Independent Variable,or Cost Driver

3. Collect data on the Dependent Variable and the Cost Driver

4. Plot the data

5. Estimate the cost function

6. Evaluate the cost driver of the estimated cost function