Topic 2: Cost Terminology and Cost Function Flashcards
(15 cards)
What are the four key cost estimation methods?
1) Industrial Engineering Method
2) Conference Method
3) Account Analysis Method
4) Quantitative Method
-This consists of the high-low method, as well as the regression method.
What are the 3 key criteria to evaluate and choose cost drivers?
1) Economic plausibility: Does it make sense that the cost driver would explain changes in the cost?
2) Goodness of fit: Does the cost equation match the underlying data? R2 varies from 0% to 100%, and the higher the %, the better, and the closer to the regression line.
3) Slope of regression: The steeper the slope, the stronger the relationship. The flatter the selop, the weaker the relationship.
What is a cost object?
The cost object is the item for which you want to measure costs, whether that’s a product, department, or customer.
What is a cost driver? What would be a cost driver for a university?
A cost driver is something that directly shifts the costs that would need to be paid by your organization. This can get specific. For a university cost drivers would be the number of students enrolled because you’d need more Teaching Assistant hours, and you may need to open more lecture sessions and pay more professors as well. A textbook will not be a cost driver, because that cost is incurred by the student.
What is cost classification? What are the four key cost classifications?
Cost classification is the process of grouping costs based on shared characteristics to make them easier to analyze, control, and use in decision making. The four key classifications are behaviour, traceability, function, and relevance.
How do we classify fixed and variable costs? What is the purpose?
-We classify fixed and variable costs by behaviour.
-That is because we must understand how consumers purchasing behaviour changes overall cost.
-If an additional unit being purchased changes total costs, it’s a variable cost.
-If an additional unit purchased doesn’t change total cost, it’s a variable cost.
-The purpose is predicting and analyzing costs.
How do we classify direct and indirect costs? What is the purpose?
-We classify direct costs and indirect costs through traceability.
-If we can clearly trace the cost to a specific product, then we can assign a direct cost and it is a direct cost.
-However, if we can not trace the cost to a specific product, then we allocate the cost and it’s an indirect cost.
How do we classify product (inventoriable) vs period costs? They can also be called manufacturing vs non-manufacturing costs.
-We classify product costs if they can be clearly tied to a product, some manufacturing, and a specific piece of inventory.
-This helps us to determine the purpose of the cost incurred.
-Period costs can not directly be tied to a specific product, and are often expensed underoperating expenses.
How do we classify whether information is relevant or irrelevant?
-We classify whether information is relevant based on three things:
1) Differential cost: the cost between two alternatives
2) Opportunity cost: The benefit foregone by choosing one option over the other.
3) Sunk cost: Previous money spent and potentially lost shouldn’t affect spending decisions.
What are the 2 major types of cost functions? What types of cost functions will they produce?
1) Linear
-Fixed Cost: Y=a. E.g. a software system that can support the whole company.
-Variable Cost: Y=bX. E.g. Direct materials where costs go up proportionally to the increase in units.
-Mixed Cost: Y=a+bX
2) Non-linear
-Step Costs: Remain fixed within a certain range but jump up when output passes a threshold.
-Learning Curve: Decreasing cost per unit as cumulative output increases–due to labourers improved efficiency.
-Economies of Scale: Decreasing cost per unit as cumulative output increases (due to improved efficiency).
What is the industrial engineering cost method? What are it’s advantages and disadvantages?
-Industrial engineering is a detailed analysis of what cost behaviour should be, based on the relationship between inputs and outputs.
-Industrial engineering can be particularly useful when no past data exists, and it can be useful for new processes or activities.
-However, it’s cons are that it is time consuming, expensive to perform, and doesn’t include manufacturing overhead.
What is the conference cost method? What are it’s advantages and disadvantages?
-The conference method gathers members of various departments to help estimate the cost functions based on analysis and opinions about costs and their drivers.
-The conference cost method can help to develop cost functions and cost estimates quickly, and gathers inputs from various departments which creates a consensus.
-However, it’s cons are that the accuracy of the information depends upon individual opinions which may be biased or subjective.
What is the account analysis cost method? What are it’s advantages and disadvantages?
-With the account analysis method, we classify costs as either fixed or variable using a qualitative rather than a quantitative approach.
-The account analysis method can be particularly useful in analyzing costs at an aggregated level–such as analyzed the cost of caring for patients in ER.
-However, some challenges with the account analysis method is that it’s not standardized, and the accuracy of the analysis depends on the individuals understanding of fixed and variable costs.
What is the high-low cost method? What are it’s advantages and disadvantages?
-The high-low method estimates a cost function based on it’s highest and lowest observed values, if the cost driver creates the relevant range.
-It’s advantages are that it’s very simple to apply and it requires only 2 data points.
-It’s disadvantage is that an unusual high or low value may skew the cost estimate.
What is the regression cost method? What are it’s advantages and disadvantages?
-The regression method seperates a mixed cost into it’s fixed and variable elements, estimating the cost function by fitting a regression line that minizes the sum of the squared errors.
-The regression analysis tool can be highly accurate because it uses all data available, and it seperates fixed and variable costs precisely.
-The disadvantages of the regression model is that it requires statistical tools and knowledge and it can be influenced by outliers or poor data.
