Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 17

A friend comes to you with the following problem. "I provided my boss a cost equation i using regression analysis. He was unhappy with the results. He told me to do more work and not return until I had a lower cost estimate for one of the variables—the number of machine-hours. My initial analysis covered the last 36 months (proving 36 observations). By dropping four months in which the relation between costs and machine-hours was very high, I was able to get a lower cost estimate for machine-hours. My boss was happy with my new results. Do you think that what I did was unethical?" How would you respond?

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Cost estimation

Cost estimation is an important exercise because it helps managers in decision making. Correct cost estimates result in cost saving and making business successful. Cost estimates helps managers to evaluate and choose the best alternative. It is important for managers to capture the correct cost for each alternative.

There different methods used for cost estimation like engineering, accounting and statistical analysis.

Statistical method

Statistical is more accurate method of cost estimation as compared to engineering and accounting analysis method as they have certain limitations. Under this method, random events are separated from while analyzing relationship between cost and activity. While using statistical method for cost estimation it is important to confirm that past activity levels are related to current estimation.

Simple regression analysis – In simple regression analysis there is only one predictor for the activity and cost is estimated on the basis on one predictor only. For example, overhead cost is estimated on the basis of relationship between total cost and parts used.

Multiple regression analysis – In multiple regression analysis more than one type of predictor is used for the activity and cost is estimated on the basis on multiple predictors. Multiple predictors are used for better and more accurate cost estimation. For example, overhead cost is estimated on the basis of parts used and labor hours used for production purpose. Only parts cost may not provide correct overhead cost estimation, hence labor hours used, must also be included as predictor to calculate overhead cost.