Chapter 10

Question 1

Study Card 1: Linear Cost Functions
What it is:
Formula

Answer 1

What it is:
A mathematical formula showing how costs change with activity levels.
Y = a + bx

Question 2

Formula: Y = a + bx

Answer 2

• Y = Total cost
• a = Fixed cost
• b = Variable cost
• X = Activity level (cost driver)

Question 3

Importance of Causality in Cost Estimation

Answer 3

Causality ensures the activity (X) directly influences the cost (Y).
Without causality, cost estimation is inaccurate.

Question 4

Methods of Cost Estimation

Answer 4

High Low Method
Regression Analysis
Visual Inspection
Engineering Estimates

Question 5

High-Low Method:

Answer 5

Uses highest and lowest activity levels to estimate cost.

Question 6

Regression Analysis

Answer 6

Uses statistical data to estimate cost.

Question 7

Steps in Estimating a Cost Function

Answer 7

1. Choose dependent (cost) and independent (activity) variables.
2. Collect data on both.
3. Plot data.
4. Estimate cost function (using high-low or regression).
5. Evaluate accuracy.

Question 8

Nonlinear Cost Functions & Learning Curves

Answer 8

Nonlinear costs: Costs that don’t follow a straight line.

Learning Curves: As production increases, per-unit costs drop due to efficiency gains.

Question 9

Quality Control as a Cost Driver

Answer 9

Quality control impacts costs:

• Prevention Costs: Measures to prevent defects.
• Appraisal Costs: Inspecting products.
• Failure Costs: Costs of defects found before or after shipment.

Implication: Strong quality control reduces overall costs.

Question 10

Data Collection Issues

Answer 10

Accuracy of data

Consistency: Data should be collected uniformly.

Relevance: Data must relate directly to the cost.

Question 11

Interpreting Regression Models

Answer 11

Intercept (a): Fixed cost.
Slope (b): Variable cost per activity unit.
R²: How well the model explains the cost.
P-Value: Shows if the relationship between cost and activity is statistically significant.

Question 12

Learning Curve Model

Answer 12

Shows how costs decrease as production increases.

Formula: Y = aX^b
a = First unit cost
b = Learning curve slope (negative)

Question 13

Relevant Range

Answer 13

The range of activity levels over which cost behavior is predictable and linear.

Outside the range: Cost behavior may change, making estimates unreliable.

Question 14

High-Low Method

Answer 14

Identify the highest and lowest activity levels.
Calculate variable cost per unit
Find fixed cost

Question 15

Regression Analysis

Answer 15

A statistical technique to estimate cost functions using all data points.
Benefits: More accurate than the high-low method, provides statistical significance (p-value).

Question 16

Scatter Plot Analysis

Answer 16

A graphical tool to see the relationship between cost driver and total cost.

A strong correlation shows that the cost driver is explaining the changes in cost.

Question 17

R² (Coefficient of Determination)

Answer 17

What it tells you:

Measures how well the cost driver explains the changes in total cost.

Higher R² means a stronger relationship (typically, a value of 0.3 or higher is good).

Question 18

Learning Curve Effect

Answer 18

As production increases, the cost per unit decreases due to increased efficiency.

Question 19

Economic Plausibility

Answer 19

Does the relationship between activity and cost make sense?
Example: More machine hours → Higher utility costs (reasonable

Question 20

Time Drivers

Answer 20

What drives time-based costs:

Uncertainty: When customers place orders.
Bottlenecks: Limited capacity causing delays.

Question 21

Balanced Scorecard & Time Measures

Answer 21

Financial: Profitability, cost control.
Customer: Response time, satisfaction.
Internal Processes: Efficiency, lead times.
Learning and Growth: Employee skills, innovation.

Question 22

Costs of Quality (COQ)

Answer 22

Prevention Costs: Training, process improvements.
Appraisal Costs: Inspections, testing.
Internal Failure Costs: Rework, scrap.
External Failure Costs: Warranty, returns.

Question 23

Control Charts

Answer 23

Monitor process variation over time.
Random variation is expected, but non-random variation requires investigation.
Control limits: Boundaries that help identify issues.

Question 24

Pareto Diagram

Answer 24

A bar chart showing the frequency of defects, ordered from most to least frequent.
80/20 Rule: Often, 80% of issues come from 20% of the causes.

Question 25

Cause-and-Effect (Fishbone) Diagram

Answer 25

A visual tool to identify root causes of defects or problems.
Resembles a fish skeleton, with the main “bone” being the problem and the “ribs” showing possible causes.