Question

Describe the account method for estimating a cost function.

1) The account analysis method estimates cost functions on the basis of analysis and opinions about cost and their drivers gathered from various departments of a company (purchasing, process engineering, employee relations, etc.)
2) The account analysis method estimates cost functions by analyzing the relationship between inputs and outputs in physical terms.
3) The account analysis method estimates cost functions by classifying cost accounts in the subsidiary ledger as variable fixed, or mixed with respect to the identified level of activity. Typically, managers use qualitative, analysis when making these cost classification decisions.
4) The account analysis method uses a formal mathematical method to fit cost functions to past data observations. Excel is a useful tool for performing the account analysis method.

Answer 1

The accounting method estimates cost functions by categorizing costs as variable, fixed, or mixed based on qualitative analysis and expert judgments, without the use of formal mathematical models. Such cost classifications are crucial for understanding the cost structure and informing strategic decision-making. Accurate calculations of total cost, average variable cost, average total cost, and marginal cost are essential for assessing costs effectively.

Step-by-step explanation:

The account analysis method for estimating a cost function involves identifying various costs as variable, fixed, or mixed based on qualitative analysis and informed judgments from different departments within a company. This estimation does not use formal mathematical methods to fit cost functions to past data observations; instead, it relies on the expertise and insights of managers and accountants to determine the costs' behaviors in relation to an identified level of activity. It is important to recognize that this method focuses on the analysis and opinions about how costs respond to changes in activity levels to aid in cost structure determination.

By breaking down total costs into categories such as fixed costs, marginal costs, average total costs, and average variable costs, businesses can gain insights that help in understanding the cost structure of the firm and making informed decisions. Such classifications are essential for providing a clearer picture of how costs will change with different production volumes and can influence strategic planning and pricing decisions.

When using the accounting method, it is also vital to calculate various cost measures accurately. Following the formulas for total cost, average variable cost, average total cost, and marginal cost, as shown in the Production, Costs, and Industry Structure chapter, is key to establishing the cost structure of the firm and making comparisons with alternative solutions or strategies.