What is cost estimation ?
What are the purposes of cost estimation ?
Management accounting relies heavily on estimates because of its orientation towards the future.
Estimation helps achieve timeliness and relevance by sacrificing reliability and accuracy.
The purpose of cost estimation is to estimate the value of the resources consumed every time
something is done. These estimates are then used as parameters of a cost function allowing
managers to predict either total costs for different volumes of activity or assess the consequences of
managerial decisions.
Cost estimation consists in assessing the parameters of a linear cost function to predict total
costs and its variations
Such cost function and its parameters serve several purposes
- In product costing they are used to compute predetermined overhead rates in normal
costing and standard costing, or in Activity-Based Costing
- In cost-volume-profit analysis they reveal the cost structure of a company and allow an
assessment of operating risks
- In budgeting, they are used to forecast costs for different levels of activity and thus assess
the amount of resources to be secured in various scenarios
- In variance analysis, they serve as benchmarks against which actual performance is
compared to identify and assess the importance of alternative sources of deviations from
budgets.
- In differential analysis, they are used to assess the economic impact of alternative courses of
action which affect activity levels, capacity levels, or the value of any parameter.
What are the different kinds of cost behaviors ?
Costs arise from the use of resources of different natures to make products or provide service.
Product (or service) costing is designed to measure, value, and record the amount of resources
which were consumed for a product or provide a service. It focuses on the resource consumption and
the two cost classifications, cost inventoriability and cost traceability.
Cost estimation is designed to assess the amount of resources which will be consumed because of the
level of activity, the available capacity, or managers’ decisions. The cost classifications cost behavior
matches this focus.
Cost behavior is a description of how a cost changes in relationship to a measure of activity called
cost driver
- Strictly proportional they always increase by the same amount for every additional unit of
activity
- Less than proportional they increase but at a lower pace
- More than proportional they increase at a faster pace
- Not proportional at all
The cost behavior classification relates to two distinct attributes of costs:
- Proportionality: to what extent is resource consumption determined, and thus proportional to, by
the level of activity
What are the purposes of cost estimation ?
Management accounting relies heavily on estimates because of its orientation towards the future.
Estimation helps achieve timeliness and relevance by sacrificing reliability and accuracy.
The purpose of cost estimation is to estimate the value of the resources consumed every time
something is done. These estimates are then used as parameters of a cost function allowing
managers to predict either total costs for different volumes of activity or assess the consequences of
managerial decisions.
Cost estimation consists in assessing the parameters of a linear cost function to predict total
costs and its variations
Such cost function and its parameters serve several purposes
- In product costing they are used to compute predetermined overhead rates in normal
costing and standard costing, or in Activity-Based Costing
- In cost-volume-profit analysis they reveal the cost structure of a company and allow an
assessment of operating risks
- In budgeting, they are used to forecast costs for different levels of activity and thus assess
the amount of resources to be secured in various scenarios
- In variance analysis, they serve as benchmarks against which actual performance is
compared to identify and assess the importance of alternative sources of deviations from
budgets.
- In differential analysis, they are used to assess the economic impact of alternative courses of
action which affect activity levels, capacity levels, or the value of any parameter.
What are the different kinds of cost behaviors ?
Costs arise from the use of resources of different natures to make products or provide service.
Product (or service) costing is designed to measure, value, and record the amount of resources
which were consumed for a product or provide a service. It focuses on the resource consumption and
the two cost classifications, cost inventoriability and cost traceability.
Cost estimation is designed to assess the amount of resources which will be consumed because of the
level of activity, the available capacity, or managers’ decisions. The cost classifications cost behavior
matches this focus.
Cost behavior is a description of how a cost changes in relationship to a measure of activity called
cost driver
- Strictly proportional they always increase by the same amount for every additional unit of
activity
- Less than proportional they increase but at a lower pace
- More than proportional they increase at a faster pace
- Not proportional at all
The cost behavior classification relates to two distinct attributes of costs:
- Proportionality: to what extent is resource consumption determined, and thus proportional to, by
the level of activity
