The following question-and-answer format summarizes the chapter’s learning objectives. Each decision presents a key question related to a learning objective. The guidelines are the answer to that question.
| Decision | Guidelines |
|---|---|
| A linear cost function is a cost function in which, within the relevant range, the graph of total costs based on the level of a single activity is a straight line. Linear cost functions can be described by a constant, a, which represents the estimate of the total cost component that, within the relevant range, does not vary with changes in the level of the activity; and a slope coefficient, b, which represents the estimate of the amount by which total costs change for each unit change in the level of the activity within the relevant range. Three types of linear cost functions are variable, fixed, and mixed (or semivariable). |
| The most important issue in estimating a cost function is determining whether a cause-and-effect relationship exists between the level of an activity and the costs related to it. Only a cause-and-effect relationship—not merely correlation—establishes an economically plausible relationship between the level of an activity and its costs. |
| Four methods for estimating cost functions are the industrial engineering method, the conference method, the account analysis method, and the quantitative analysis method (which includes the high-low method and the regression analysis method). If possible, the cost analyst should use more than one method. Each method is a check on the others. |
| There are six steps to estimate a cost function using quantitative analysis: (a) Choose the dependent variable, (b) identify the cost driver, (c) collect data on the dependent variable and the cost driver, (d) plot the data, (e) estimate the cost function, and (f) evaluate the cost driver of the estimated cost function. In most situations, working closely with operations managers, the cost analyst will cycle through these steps several times before identifying an acceptable cost function. |
| Three criteria for evaluating and choosing cost drivers are (a) economic plausibility, (b) goodness of fit, and (c) the significance of the independent variable. |
| A nonlinear cost function is one in which the graph of total costs based on the level of a single activity is not a straight line within the relevant range. Nonlinear costs can arise because of quantity discounts, step cost functions, the dependent variable taking on a limited set of values (for example, a binary variable), and learning-curve effects. When learning effects are present, labor-hours per unit decline as units of production increase. With the cumulative average-time learning model, the cumulative average-time per unit declines by a constant percentage each time the cumulative quantity of units produced doubles. With the incremental unit-time learning model, the time needed to produce the last unit declines by a constant percentage each time the cumulative quantity of units produced doubles. |
| The most difficult task in cost estimation is collecting high-quality, reliably measured data on the costs and the cost driver. Common problems include missing data, extreme values of observations, changes in technology, and distortions resulting from inflation. |