Cost estimation involves determining the relationship between costs and activity levels using historical data. There are several types of cost behaviors such as variable, fixed, and semi-variable costs. Managers must understand these cost behaviors to predict how costs will change with activity levels. Common cost estimation methods include account classification, regression analysis, visual fitting, high-low analysis, and engineering estimates. These methods analyze past cost and activity data to develop cost behavior models. Accurate cost estimation requires high quality source data without issues like missing information, outliers, or inconsistent time periods.

2. Presented to
Madam Ummara Sehar
Presented by
M.Asghar (St.# 2011-1031)
M.Bilal Bashir (St.# 2011-1043)

3. Activity Analysis, Cost Behavior and Cost Estimation
The relationship between cost estimation, cost behavior and
cost prediction.
Cost Estimation Cost Behavior Cost Prediction
For managers to predict how costs will be
affected by changes in an organization`s
activity, they must understand the relation
between these three categories and use a
little magic.

4. Activity Analysis, Cost Behavior and Cost Estimation
Cost BehaviorCost Estimation Cost Prediction
The process of
determining
cost behavior.
Often focuses
on historical
data
The
relationship
between cost
and activity
Using
knowledge of
cost behavior
to forecast at a
particular
level of
activity. Focus
is on the
future

5. Types of costs
Variable cost
Fixed cost
Step-variable cost
Step-fixed cost
Curvilinear cost

6. Cost In total Per unit
Variable Total variable cost
changes as activity level
changes.
Variable cost per unit
remains the same over
wide ranges of activity.
Variable Cost

7. Semi-variable Costs
There are certain costs which are partly fixed and
partly variable. These can be described as semi-
variable costs or semi-fixed cost.

8. Step-Variable Costs
Step-Variable costs are nearly variable, but increase in
small steps instead of continuously.

9. Cost In total Per unit
Fixed Total fixed cost remains
the same even when the
activity level changes.
Fixed cost per unit goes
down as activity level goes
up.
Fixed Costs

10. Step-Fixed Costs
Step-fixed costs remain fix over a wide range of
activity but jump to a different amount for activity
levels outside that range.

11. Curvilinear Costs
Curvilinear costs are costs that vary with the volume of
activity but not in constant proportion.

12. Relevant Range
Relevant range is the range of activity over which the
firm expects a set of cost behaviors to be consistent.

13. Engineered, committed, and discretionary Costs
The distinction between engineered, committed, and
discretionary costs.
Engineered
Cost
Committed
Cost
Discretionary
Cost
In the process of budgeting costs, it is useful
for management to make distinction
between engineered, committed, and
discretionary costs.

14. Committed CostEngineered Cost Discretionary cost
An engineered
cost bears a
definitive physical
relationship to
the activity
measure.
A committed cost
results from an
organization`s
ownership or use of
facilities and its
basic organization
structure.
A discretionary cost
arises as a result of a
management decision
to spend a particular
amount of money for
some purpose.
Engineered, committed, and discretionary Costs

15.  Cost estimation is the process of determining how a
particular cost behaves.
 Several methods (simple and sophisticated ) are
commonly used to estimate the relationship between
cost and activity.
Cost Estimation

16. Methods Of Cost Estimation
Account-Classification Method
Least-Squares Regression Method
Visual-Fit Method
High-Low Method
Engineering Method of Cost estimation

17.  Review each account comprising the total cost being
analyzed.
 Identify each cost as either fixed or variable.
Account-Classification Method
Estimate costs using account analysis
Fixed Variable

18. A scatter diagram of past cost
behavior may be helpful in analyzing
mixed costs.
Visual-Fit Method

19. Plot the data points on a graph (total
cost vs. activity).
0
10
20
1 2 3 54
Visual-Fit Method

20. • This is a method to estimate cost based on two cost
observations, the highest and lowest activity level.
High
Low
Change
$12,883
$ 9,054
$ 3,829
568
200
368
Month
Overhead
costs
Repair-
hours
5 - 20
High-Low Method

21. Variable cost per unit (V) =
(Cost at highest activity level – Cost at lowest activity level)
(Highest activity level – Lowest activity level)
5 - 21
High-Low Method
Variable cost
per RH (V)
=
($12,883 – $9,054)
568 RH – 200 RH
=
$3,829
368 RH
=
$10.40
per RH
Now we can compute the total variable cost
at either high or Low activity level.

22. 0 1 2 3 4
10
20
0
*
*
**
*
*
*
**
*
X
Y
High-Low Method
Low activity
level
High activity
level

23. • This is a method to estimate cost based on two cost
observations, the highest and lowest activity level.
High
Low
Change
$12,883
$ 9,054
$ 3,829
568
200
368
Month
Overhead
costs
Repair-
hours
Least-Squares Regression Method

24. A method used to analyze mixed costs if a
scattergraph plot reveals an approximately linear
relationship between the X and Y variables.
This method uses all of the
data points to estimate
the fixed and variable
cost components of a
mixed cost.
The goal of this method is
to fit a straight line to the
data that minimizes the
sum of the squared errors.
Least-Squares Regression Method

25.  Software can be used to fit
a regression line through
the data points.
 The cost analysis objective
is the same: Y = a + bX
Least-Squares Regression Method

26. 0 1 2 3 4
TotalCost
10
20
0
Activity
*
*
**
*
*
*
**
*
X
Y
Least-Squares Regression Method

27. Cost estimates are based on measurement
and pricing of the work involved
Engineering Method of Cost estimation

28. Engineering Method of Cost estimation
Direct Labor Direct Material
•
Analyze the kind of work
performed.
•
Estimate the time required
for each labor skill for each
unit.
•
Use local wage rates to
obtain labor cost per unit.
Material required for each
unit is obtained from
engineering drawings and
specification sheets.
•
Material prices are
determined from vendor bids.

29. Regardless of method used, results will only be as good
as the quality of the data used. Problems include
 Missing data
 Outliers
 Allocated and discretionary costs
 Inflation
 Mismatched time periods
 Trade-offs in choosing time period
29
LO 6
Data Collection Problems