The account analysis method estimates cost functions by classifying various cost accounts as variable, fixed, or mixed with regard to the identified level of activity. Typically, managers use qualitative rather than quantitative analysis to make these cost-classification decisions.
Consider the indirect manufacturing labor costs for a production area (or cell) at Elegant Rugs. These include the wages paid for supervision, maintenance, quality control, and setups. During the most recent 12-week period, Elegant Rugs ran the machines in the cell for a total of 862 hours and incurred total indirect manufacturing labor costs of $12,501. Using qualitative analysis, the manager and the management accountant determine that indirect manufacturing labor costs are mixed costs with only one cost driver—machine-hours. As machine-hours vary, one component of the cost (such as supervision cost) is fixed, whereas another component (such as maintenance cost) is variable. To estimate a linear cost function for the cell’s indirect manufacturing labor costs using number of machine-hours as the cost driver, they distinguish between variable and fixed cost components. Using experience and judgment, they divide total indirect manufacturing labor costs ($12,501) into fixed costs ($2,157) and variable costs ($10,344) based on number of machine-hours used. The variable cost per machine-hour is Therefore, the linear cost equation, is
Elegant Rugs’ managers can use the cost function to estimate the indirect manufacturing labor costs of using, say, 1,000 machine-hours to produce a new style of carpet in the next 12-week period. The estimated costs equal Indirect manufacturing labor cost per machine-hour at 862 machine-hours is At 1,000 machine-hours, it decreases to because fixed costs of $2,157 are spread over a greater number of machine-hours.
The account analysis method is widely used because it is reasonably accurate, cost effective, and easy to use. To obtain reliable estimates of fixed and variable components of cost, organizations must ensure that individuals with thorough knowledge of the operations make the cost-classification decisions. Supplementing the account analysis method with the conference method improves credibility. The accuracy of the account analysis method depends on the accuracy of the qualitative judgments about which costs are fixed and which are variable.