Cost Estimation Notes

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Summary

Expected learning outcomes
By the end of the lesson the learners should be able to
1. Define the term cost estimation
2. Explain the goals of cost estimation
3. Explain the methods of cost estimation
COST ESTIMATIONS
Mixed costs contain both a fixed component and a variable component. In order to determine the
two components, managers must separate the mixed cost into the two cost components-fixed costs
and variable costs. Breaking mixed costs into fixed and variable portions allows managers to use
the costs to predict and plan for the future given the insight on that cost behavior provides. The
process of separating mixed costs into fixed and variable components is referred to as cost
estimation. This chapter will present four methods used by managers to estimate costs.
Cost Estimation Methods
The four methods of cost estimation to be covered in managerial accounting are listed below.
Account analysis
Scatter graphs
High-low method
Linear regression
Cost estimation methods are necessary only for costs that are identified as mixed costs. There is
no need to apply an estimation method to break a cost into fixed and variable portions if you have
already determined it is solely fixed or solely variable. All four methods produce estimates of
amounts of fixed and variable costs.
Cost Estimation: As against ascertainment of actual costs, costs may also be predetermined. Cost
estimation is the process of predetermining cost of goods or services. These costs are prepared in
advance of production and preceded the operations. Estimated costs are definitely the future costs
and are based on the average of the past actual costs adjusted for anticipated changes in future.
Cost estimates may have the following uses:
1. Cost estimates are used in making price quotations and bidding for contracts.
2. Cost estimates are used in the preparation of budgets.
3. It helps in evaluating performance.
4. It is used in preparing projected financial statements.
5. Cost estimates may serve as targets in controlling the costs.
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