Chapter 3
Cost behaviour, cost drivers and cost estimation
Copyright ª 2006 McGrawHill Australia Pty Ltd
3 1
What are cost behaviour, cost estimation and cost prediction?
• Cost behaviour
– The relationship between a cost and the level of activity or cost driver
• Cost estimation
– The process of determining the cost behaviour of a particular cost item
• Cost prediction
– Using knowledge of cost behaviour to forecast the level of cost at a particular level of activity
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith
3-2
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith
3-3
Cost drivers
• A cost driver
– An activity or factor that drives or causes costs
– The higher the correlation between the cost and the cost driver, the more accurate is the description and understanding of cost behaviours
– Cost allocation base is commonly used instead of cost driver, as the causal relationship may not always exist
– Conventional understandings of cost behaviour regard costs as variable or fixed, based on the level of production volume
– Volume-based cost drivers include units produced, direct labour hours, direct labour cost and machine hours
continued
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith
3-4
Cost drivers
• Contemporary viewpoints recognise that there are a range of possible cost drivers other than production volume (non-volume cost drivers)
• Activity-based approaches classify costs and cost drivers into four levels:
– Unit
– Batch
– Product – Facility
continued
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith
3-5
Cost drivers
• Unit level costs
– Relate to activities that are performed for each unit produced
– Use conventional volume-based cost drivers • Batch level costs
– Relate to activities performed for a group of product units • Product (or product-sustaining) level
– Relate to activities performed for specific products or product groups
• Facility level
– Costs incurred to run the business
continued
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith
3-6
Cost drivers
• Selecting the best cost drivers – Input or outputs?
One input cost driver is the weight of material
One output driver is the number of units of production Cost–benefit principles will determine the choice
– How detailed should the analysis be?
As the number of cost categories increases, the accuracy of the resulting information should increase
Again, cost–benefit criteria are important – Long or short term?
Cost behaviour and cost drivers can change over time Depends on the purpose of the cost prediction
continued
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith
3-7
Cost drivers
• Cost drivers for cost estimation or cost management?
– Cost drivers that are used to predict costs may differ from those used to manage costs
– Effective cost management requires the identification of root cause cost drivers
The basic costs that cause a cost to be incurred The true causes of costs
continued
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith
3-8
Cost drivers
• In choosing cost drivers, the costs and benefits of each driver must be assessed
– Reasons for analysing cost behaviour
– Timeframes for analysing the cost behaviour – Availability of data on cost drivers
– Any other uses for the cost behaviour information
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith
3-9
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith
3-10
Cost behaviour patterns
• Cost behaviour
– The relationship between a cost and the level of activity • Cost behaviour patterns
– Variable costs – Fixed costs
– Step-fixed costs
– Semivariable costs – Curvilinear costs
continued
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith
3-11
Cost behaviour patterns
• Variable costs
– A change, in total, that is in direct proportion to a change in the level of activity
– The variable cost is the slope of the cost line in the following cost function:
Y = a + bX
Where Y = total cost
a = fixed cost component (the intercept on the vertical axis) b = variable cost per unit of activity (the slope of the line)