The Cause and Effect of a Cost System

Sep 10, 2014

I tripped over a crack in the sidewalk and scraped my knee; it is raining outside and I got wet; my feet were cold so I put on socks and my feet are now warm. The sky is blue my hair is blonde; today is Wednesday my phone rang; I sit a desk all day and it is raining. Hopefully, you were able to see the causation in my first sentence. For instance, I got a scrape on my knee because I tripped on the sidewalk. However, the fact that the is sky blue  has nothing to do with my hair being blonde. This cause and effect relationship is not always so apparent in a costing framework.

Cause-EffectWhen allocating costs that cannot be directly assigned to a product or process, they need to be assigned based on a specific driver or, something that causes those costs to occur. For example, labor costs occur because of an individual directly working on a product. Or electrical costs are being incurred due to machinery running, etc. Typical drivers are machine hours, labor hours, square footage, or some other similar factor. The important thing is that the driver does have some correlation, meaning when the driver occurs a cost is incurred.

There are statistical techniques used to determine how directly correlated two or more items are. What types of techniques have you used? One I use often is regression analysis.

Regression analysis is a statistical technique done in Excel. Regression estimates the relationship between a dependent and independent variable. Meaning, regression determines how a dependent variable will change when one of the independent variables changes, holding all else constant. Regression uses the coefficient of determination, or R squared to determine how closely related two items are. This helps to eliminate any possible correlation without causation. Regression is an excellent statistical tool, but again it cannot be used inside of a vacuum but some additional analysis should be performed. Regardless as of what technique you are using, it is important to verify that the allocations are done are based on actual cause and effect relationships. Arbitrarily assigning costs will give you unreasonable arbitrary results.

Categories: Cost Accounting