chapter 2

• budget is a quantitative roadmap of the financial operations and acts as a benchmark for monitoring and evaluating business performance
• cost behavior refers to the reaction of the total cost to changes in activity
• cost estimation is the process of measuring the past relationship of cost with the activity base
• variable cost varies proportionally in total amount and remains fixed in unit variable cost
• in variable cost, the cost increases when the activity level increased. when no table is produce, variable cost is zero
• total activity level x unit variable cost = total variable costs
• fixed cost remains constant in total and changes inversely in unit fixed cost
• mixed cost varies in total mixed cost but not directly proportional to the change in activity level; does not remain constant in unit fixed cost but changes inversely to the change in activity level
• in mixed cost, even no product is produced, it still incurs a fixed cost, and as the activity level increases, semi variable cost also increases
• relevant range is the range of activity where the assumption on cost behavior holds true— behavior of cost remains only valid here
• relevant range of variable cost is approximately linearity related to the production volume
• in actual world, actual variable cost of business do not perfectly move proportionately with the activity level due to various factors
• actual production volume is influence by other factors other than production volume while the predicted cost considers only the production volume
• relevant range of fixed cost does not have linearity with the activity levl—remains constant in total within the relevant range
• fixed cost includes salary of plant supervisor, factory rent and plant insurance
• mixed cost relevant range is difficult to predict— a need to split in order to facilitate projection
• the behavior of cost within its relevant range is the fundamental principle to estimate cost
• methods to estimate cost are quantitative and qualitative
• qualitative method is subjective in nature and largely dependent on managerial judgment
• the variations under qualitative methods are conference, account analysis and industrial engineering
• conference method uses the opinion of experts from different departments
• on conference method, estimated costs are developed and classified whether variable or fixed— initial step in estimating cost
• in conference method, classification of cost and estimation depends on care and credibility of the people involved in the analysis
• account analysis method involves deeper analysis and evaluation of the account or item— accountant and manager conduct critical analysis and evaluation of transactions
• in account analysis, cost is initially classified as fixed or variable—basis for cost estimation
• industrial engineering method is based on the result of the study conducted by industrial engineers about relationship between required input to produce an output
• industrial engineering is a costly method but the most logical and scientific qualitative method; quite expensive and time consuming
• industrial engineering method involves a detailed analysis of the process to manufacture a product and the expected cost
• quantitative method involved historical date; time series projection that is based on the trend experience by the business
• in splitting mixed cost, there is a linear relationship between the cost and cost driver, and variation in cost can be explained by a single cost driver
• cost driver driver or causes the incurrence of costs
• relationship between cost and cost driver does not require a perfect linear relationship
• cost function is expressed in y= a + bx requires only one cost driver
• if there are many factors, it is usually determined by conducting regression analysis
• high low method uses the highest and lowest activity level of the cost driver
• high low method assumes that activity level drives the incurrence of semi-variable cost and any change in variable cost creates a change in total cost
• outlier data are from levels of activity which are considered abnormal or not typical compared to the rest of the data
• high-low method

  variable: cost of highest activity level - lowest activity level / highest activity level - lowest activity level
• fixed cost must remain constant in total in high-low method
• scattergraph method makes use of two-dimensional graph to split the semi-variable costs—linear relationship between two variables