Management Accounting
Chapter 9:
A cost function is a mathematical function describing cost behavior patterns-how costs change with
changes in the cost driver.
Two assumptions are made frequently when estimating cost functions:
1. Variations in the total costs of a cost-object are explained by variations in a single cost driver
2. Cost behavior is adequately approximated by a linear cost function (a cost function, where
within the relevant range, the graph of total costs versus a single cost driver forms a straight
line) of the cost driver withing the relevant range.
Slope coefficient: the amount by which total costs change for a unit change in the cost driver within
the relevant range
constant/intercept: the component of total costs that, within the relevant range, does not vary with
changes in the level of the cost driver
mixed cost (semivariable cost): a cost that has both fixed and variable elements
cost estimation: the attempt to measure past cost relationships between total costs and the drivers
of those costs
โ these estimations can help them make more accurate cost predictions: forecasts about future
costs
Three specifications necessary to classify costs into their variable and fixed components:
โChoice of cost object: A particular cost item could be variable with respect to one cost object
and fixed with respect to another
โTime span: Wether a cost is variable or fixed with respect to a particular driver depends on
the time span considered in the decision situation. The longer the time span, other things
being equal, the more likely that the cost will be variable
โRelevant range: Accountants and managers use linear cost functions to approximate the
relation of total costs to cost drivers within a relevant range
The cause-and-effect criterion in choosing cost drivers:
The most important issue in estimating a cost function is to determine wether a cause-and-effect
relationship exists between the cost driver and the resulting costs.
โ might arise in several ways:
โIt may be due to a physical relationship between costs and the cost driver
โCan arise from a contractual agreement
โCan be implicitly established by logic and knowledge of operations
Be careful not to interpret a high correlation or connection between two variables to mean that
either variable causes the other.
Establishing economic plausibility is a vital aspect of cost estimation.
Cost estimation approaches:
โindustrial engineering method
โconference method
โaccount analysis method
โquantitative analysis of current or past cost relationships
These approaches differ in the costs of conducting the analysis, the assumptions they make, and the
evidence they provide about the accuracy of the estimated cost function.
Industrial engineering method (work-measurement method): estimates cost functions by
