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

Exercise 14

When using past data to predict a cost that has fixed and variable components, it is possible to have an equation with a negative intercept. Does this mean that at a zero production level, the company will make money on its fixed costs? Explain.

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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.

High-low method of cost estimation

Under High-low method of cost estimation, variable cost is calculated by considering the total cost at highest and lowest level. The difference of total cost at highest and lowest activity level are divided by the difference of highest and lowest activity level to calculate variable cost per unit. This method compensates the price instability by considering the highest and lowest level of total cost and the activity level at those two points.

Same way fixed cost is calculated by deducting variable cost at lowest activity level from total cost at lowest activity level.