BEA2010 Managerial Accounting
Seminar assignment 2: Cost Behaviour and Estimation – Solutions
Answers to Review Questions
1. Cost behavior patterns are important in the process of making cost predictions. Cost predic-
tions are used in planning, control, and decision making. For example, cost budgets are based
on predictions of costs at various levels of activity. Cost control is accomplished by compar-
ing actual costs against budgeted costs, which are based on cost predictions. Cost predictions
are also important in decision making, since the desirability of various alternatives often de-
pends on the costs that will be incurred under those alternatives.
2. a. Cost estimation is the process of determining how a particular cost behaves.
b. Cost behavior is the relationship between cost and activity.
c. Cost prediction is the forecast of cost at a particular level of activity.
Cost estimation determines the cost behavior pattern, which is used to make a cost prediction
about the cost at a particular level of activity contemplated in the future.
3. As the level of activity (or cost driver) increases, total fixed cost remains constant. However,
the fixed cost per unit of activity declines as activity increases.
4. A manufacturer's cost of supervising production might be a step-fixed cost, because one su-
pervisor is needed for each shift. Each shift can accommodate a certain range of production
activity; when activity exceeds that range, a new shift must be added. When the new shift is
added, a new production supervisor must be employed. This new position results in a jump in
the step-fixed cost to a higher level.
5. The cost analyst should respond by pointing out that in most cases a cost behavior pattern
should be limited to the relevant range of activity. When the firm's utility cost was shown as a
semivariable cost, it is likely that only some portion in the middle of the graph would fall
within the relevant range. Within the relevant range, the firm's utility cost can be approximat-
ed reasonably closely by a semi-variable cost behavior pattern. However, outside that range
(including an activity level of zero), the semivariable cost behavior pattern should not be used
as an approximation of the utility cost.
6. A learning curve shows how average labor time per unit of production changes as cumulative
output changes. In many production processes, as production activity increases and learning
takes place, there is a significant reduction in the amount of labor time required per unit. The
1
, learning phenomenon is important in cost estimation, since estimates must often be made for
the level of cost to be incurred after additional production experience is gained.
7. Appropriate independent variables for several tasks are as follows:
a. Handling materials at a loading dock: Weight of materials handled.
b. Registering vehicles at a county motor vehicle office: Number of registrations processed.
c. Picking oranges: Volume or weight of oranges picked.
d. Inspecting computer components in an electronics firm: Number of components inspect-
ed.
8. An outlier is a data point that falls far away from the other points in the scatter diagram and is
not representative of the data. One possible cause of an outlier is simply a mistake in record-
ing the data. Another cause of an outlier is a random event that occurred, which caused the
cost during a particular period to be unusually high or low. For example, a power outage may
have resulted in unusually high costs of idle time for a particular time period. Outliers should
be eliminated from a data set upon which cost estimates are based.
9. The term least squares in the least-squares regression method of cost estimation refers to the
process of minimizing the sum of the squares of the vertical distances between the data and
the regression line.
10. A least-squares regression line may be expressed in equation form as follows:
Y = a + bX
In this equation, X is referred to as the independent variable, since it is the variable upon
which the estimate is based. Y is called the dependent variable, since its estimate depends on
the independent variable. The intercept of the line on the vertical axis is denoted by a, and the
slope of the line is denoted by b. Within the relevant range, a is interpreted as an estimate of
the fixed-cost component, and b is interpreted as an estimate of the variable cost per unit of
activity.
11. In simple regression there is a single independent variable. In multiple regression there are
two or more independent variables.
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Seminar assignment 2: Cost Behaviour and Estimation – Solutions
Answers to Review Questions
1. Cost behavior patterns are important in the process of making cost predictions. Cost predic-
tions are used in planning, control, and decision making. For example, cost budgets are based
on predictions of costs at various levels of activity. Cost control is accomplished by compar-
ing actual costs against budgeted costs, which are based on cost predictions. Cost predictions
are also important in decision making, since the desirability of various alternatives often de-
pends on the costs that will be incurred under those alternatives.
2. a. Cost estimation is the process of determining how a particular cost behaves.
b. Cost behavior is the relationship between cost and activity.
c. Cost prediction is the forecast of cost at a particular level of activity.
Cost estimation determines the cost behavior pattern, which is used to make a cost prediction
about the cost at a particular level of activity contemplated in the future.
3. As the level of activity (or cost driver) increases, total fixed cost remains constant. However,
the fixed cost per unit of activity declines as activity increases.
4. A manufacturer's cost of supervising production might be a step-fixed cost, because one su-
pervisor is needed for each shift. Each shift can accommodate a certain range of production
activity; when activity exceeds that range, a new shift must be added. When the new shift is
added, a new production supervisor must be employed. This new position results in a jump in
the step-fixed cost to a higher level.
5. The cost analyst should respond by pointing out that in most cases a cost behavior pattern
should be limited to the relevant range of activity. When the firm's utility cost was shown as a
semivariable cost, it is likely that only some portion in the middle of the graph would fall
within the relevant range. Within the relevant range, the firm's utility cost can be approximat-
ed reasonably closely by a semi-variable cost behavior pattern. However, outside that range
(including an activity level of zero), the semivariable cost behavior pattern should not be used
as an approximation of the utility cost.
6. A learning curve shows how average labor time per unit of production changes as cumulative
output changes. In many production processes, as production activity increases and learning
takes place, there is a significant reduction in the amount of labor time required per unit. The
1
, learning phenomenon is important in cost estimation, since estimates must often be made for
the level of cost to be incurred after additional production experience is gained.
7. Appropriate independent variables for several tasks are as follows:
a. Handling materials at a loading dock: Weight of materials handled.
b. Registering vehicles at a county motor vehicle office: Number of registrations processed.
c. Picking oranges: Volume or weight of oranges picked.
d. Inspecting computer components in an electronics firm: Number of components inspect-
ed.
8. An outlier is a data point that falls far away from the other points in the scatter diagram and is
not representative of the data. One possible cause of an outlier is simply a mistake in record-
ing the data. Another cause of an outlier is a random event that occurred, which caused the
cost during a particular period to be unusually high or low. For example, a power outage may
have resulted in unusually high costs of idle time for a particular time period. Outliers should
be eliminated from a data set upon which cost estimates are based.
9. The term least squares in the least-squares regression method of cost estimation refers to the
process of minimizing the sum of the squares of the vertical distances between the data and
the regression line.
10. A least-squares regression line may be expressed in equation form as follows:
Y = a + bX
In this equation, X is referred to as the independent variable, since it is the variable upon
which the estimate is based. Y is called the dependent variable, since its estimate depends on
the independent variable. The intercept of the line on the vertical axis is denoted by a, and the
slope of the line is denoted by b. Within the relevant range, a is interpreted as an estimate of
the fixed-cost component, and b is interpreted as an estimate of the variable cost per unit of
activity.
11. In simple regression there is a single independent variable. In multiple regression there are
two or more independent variables.
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