M3A1: Discussion—Absorption versus Variable Costing

Cost estimation is the process of estimating the relationship between costs and cost drivers that are responsible for the costs. There are three main reasons why companies estimate costs. These are:

· To manage costs

· To make decisions

· To plan and set standards

There is a simple way and a complex way to break down costs. The simple way is to break down costs into fixed and variable costs. The complex way is to make cost patterns, such as step costs and mixed costs. There are three commonly used methods when it comes to cost estimation. These methods are:

· Statistical methods using regression analysis

· Account analyses

· Engineering estimates

Statistical methods using regression analysis employ cost drivers, which are independent variables and costs, which are dependent variables. When simple regression is used, there is one independent variable. When multiple regression is used, there is more than one independent variable.

With account analyses, the analyst separates costs from the accounting records into categories and their corresponding cost drivers. With the engineering estimates method, engineers create estimates based on the data derived from current practices. These estimates are found by measuring the amount of work involved to complete the activity and then assigning a cost to each activity. It is important to note that statistical methods require the least amount of data as costs are not divided into categories with cost drivers. Engineering estimates are the most expensive and time consuming as identifying activities and their costs is difficult.