Chapter 6: Cost Estimation

Summary

Cost estimation is one of the most important activities the management accountant per-forms in supporting the firm’s strategy. It has an important role in developing a strategic competitive position as well as in using value-chain analysis, target costing, and other planning and evaluation contexts within cost management.

To use cost estimation effectively, the management accountant develops and evaluates a cost-estimating model in six steps: (1) define the cost object, (2) determine the cost drivers, (3) collect consistent and accurate data, (4) graph the data, (5) select and apply a cost estimation method, and (6) evaluate the accuracy of the cost estimate.

This chapter presents three estimation methods. The high-low method develops a unique estimation equation using algebra and the representative low and high points in the data. Two statistical methods, work measurement and regression analysis, also are presented. Work measurement is a study of a work activity to measure the time or in-put required per unit of output. Regression analysis obtains a unique best-fitting line for the data. The chapter’s focus is on the proper interpretation of the three key measures of the precision and reliability of the regression: R-squared, the t-value, and the standard error of the estimate.

In applying any cost estimation method management accountants consider the three main implementation problems: (1) inaccurate data, (2) mismatched data from different time periods and time periods that are too short or too long, and (3) nonlinearity in the data.

The most reliable and accurate method available to the management accountant is regression analysis, which can be solved using spreadsheet software such as Microsoft Excel. An advantage of regression analysis is that its results include quantitative and objective measures of the reliability and accuracy of the regression estimate.