QUANTITATIVE ANALYSIS IN BUDGETING

Learning curves

It is a human phenomenon that occurs because of the fact that people get quicker at performing repetitive tasks once

they have been doing them for a while. The first time a new process is performed, the workers are unfamiliar with

it. As the process is repeated the workers become more familiar with it and better at performing it. This means that

it takes them less time to complete it.

The learning process starts as soon as the first unit or batch comes off the production line.
Application of learning curve theory

Labour time should be expected to get shorter, with experience, in the production of items which exhibit any or all

of the following features.

1. When product is made largely by labour effort

2. It is necessary for the process to be a repetitive one

3. There needs to be a continuity of workers and they mustn’t be taking prolonged breaks during the production

process

4. Brand new product

5. Short life products (will have more effect of learning curve)

6. Complex products made in small quantities for special orders

7. Applied on homogenous products

The learning rate

Where a learning curve applies, there is a learning rate.

The learning rate is expressed as a percentage value, such as an 80% learning curve or a 70% learning curve.

Learning curve - methods

1. Tabular approach

2. Algebraic approach

Tabular approach

The tabular approach is quicker and easier when it can be used, but it can be used only for a limited type of

problem.

The tabular approach can only be used to calculate average times when cumulative output doubles.
The specific learning curve effect is that the cumulative average time per unit decreased by a fixed percentage each

time cumulative output doubled.

Example

Time to make first unit = 50 hours

learning rate = 90%

Cumulative Cumulative average time per Total time Incremental total Average

output(units) unit (hours) time Hours/unit

1 50 50

2 45 90 40 40 (40/1)

4 40.50 162 72 36 (72/2)

8 36.45 291.6 129.6 32.4 (129.6/4)

Time taken for the first unit = 50 hours

Cumulative average time per unit for the first 2 units = 45 hours

total time for the first 2 units = 90 hours

time taken for the second unit = 40 hours

Time required to produce 2nd unit = total time for the 2 units - total time for 1 unit

so time required to produce 3rd unit is = total time for 3 units - total time for 2 units

total time for 3 units = cumulative average time per unit for 3 units * 3

Example

Company has designed a new type of sailing boat, for which the cost of the first boat to be produced has been

estimated as follows.
 $

Materials 5,000

Labour (800 hrs  $5 per hr) 4,000

overhead (150% of labour cost) 6,000

Total cost 15,000

Profit mark-up (20%) 3,000

Sales Price 18,000

It is planned to sell all the units at full cost plus 20%. An 80% learning curve is expected to apply to the production

work. The management accountant has been asked to provide cost information so that decisions can be made on

what price to charge.

Required

1. What is the selling price of second unit ?

2. What would be the total cost for the first 4 units ?

Derivation of the learning rate

Example

BL is planning to manufacture a new product, product A. The labour hours for the first unit is estimated to be 720 ,

while the total labour hours for producing first four units will be 1620.

Required

Calculate the rate of learning

Algebraic approach

Where

y = cumulative average time per unit to produce x units

a = the time taken for the first unit of output

x = the cumulative number of units produced

b = the index of learning (log LR/log2)

LR = the learning rate as a decimal

Example

Suppose that an 80% learning curve applies to production of a new product item ABC. The time to make the very

first unit of ABC was 120 hours. The labour cost is $10 per hour.

Required

Calculate the time required to make the 31st unit.

Cessation of learning

As long as a learning curve effect applies, the time taken to produce each additional unit is less than the time for the

previous unit.

A time will be reached when the learning effect no longer applies and steady state of production will reach for a

product.

When a steady state point is reached a standard time and labour cost for the product can be established.
 th
For example if learning ceases at 30 units. The time it takes to make 30 unit will be time required to make the rest

of the units.

Limitations of learning curve

• It is only applicable in labour intensive operations which are repetitive and reasonably skilled.

• It assumes that employees are motivated to learn.

• It assumes that there is a stable labour mix with a negligible turnover.

• Difficulty in determining the learning curve effect accurately.

• Difficulty in determining the level of production where the curve will be flat and no further learning takes place.

• Breaks between production runs must be short or learning will be forgotten.

 HIGH LOW METHOD

• High low method is used to determine fixed and variable elements of mixed (semi variable) cost.

• It can also be used for estimating the total cost for a particular activity level.

• It relies on the assumption that mixed costs are linear.

Total Cost Function

Total cost is a type of mixed cost

Total cost = Fixed cost + Variable cost/unit * units

TC = FC + VC/U * U

This is in the form of y = a + bx

y is the dependent variable that is the total cost for the period at the activity level of x

x is the independent variable that is the activity level

 a is the constant that is the total fixed cost for the period

b is also a constant that is the variable cost per unit of activity

Steps

1. Identify two different levels of activities: the highest and the lowest level of activities and the corresponding

costs.

2. Find the variable cost per unit

3. Compare the variable cost with the total costs at either the lowest activity level or highest activity level to

compute the total fixed cost.

4. Calculate total cost

Example

Company has recorded the following total costs during the last five years.
 Year Output volume (Units) Total cost ($)

20X0 65,000 145,000

20X1 80,000 162,000

20X2 90,000 170,000

20X3 60,000 140,000

20X4 75,000 160,000

Required

Calculate the total cost that should be expected in 20X5 if output is 85,000 units.
The high-low method with stepped fixed costs

Example

The following data relate to the total cost at two activity levels

Units produced Total cost

12,750 $73,950

15,100 $83,585

When more than 14,000 units are produced there will be a step up in fixed cost of $4700

Required

Calculate the estimated total cost for 14,500 units

 Forecasting

Regression Analysis

Regression analysis is the study of the relationship between variables. It is one of the most commonly used business
analysis tools and easy to use.

Dependent variable is the single variable is being explained/predicted by regression model. Independent variable is the
explanatory variable used to predict dependent variable.

Y = a + bx

Where,

Y = Dependent variable

X = Independent variable

a = intercept

b = gradient
Correlation

Two variables are said to be correlated if a change in the value of one variable is accompanied by a change in the value
of another variable.

For example:

• Total variable cost and production units

• Selling price of a product and its demand.

The purpose of correlation analysis is to measure and interpret the strength of linear relationship between two variables.

Degrees of correlation

Two variables might be perfectly correlated, partly correlated or uncorrelated. Correlation can be positive or negative.
Positive and negative correlation
Positive correlation means that the low values of one variable are associated with low values of other, and high values of
one variable are associated with high values of other.

Negative correlation means that the low values of one variable are associated with high values of other, and high values
of one variable are associated with low values of other.
Correlation coefficient (r)

It express degree of linear correlation between two variables.

It is from +1 to -1.
Example
Example

Time Series Analysis

A time series is a series of figures relating to the changing value of a variable over time. The data often conforms to a
certain pattern over time. It is use to forecast sales.

The components of a time series

• The trend this describes the long term general movement of the data recorded.
• Seasonal variations are short term fluctuations in values, a regular variation due to different circumstances which
occur at different times of the year
• Cyclical variations are long term fluctuations in values due to economic cycle
 • Random variations irregular, random fluctuations in the data usually caused by irregular items, which cannot be
predicted

Trend

In time series analysis the trend is measured by

1. Inspection
2. Regression analysis
3. Moving averages

Seasonal Variation

There are two models use to find out seasonal variations:

Additive model

Seasonal variations are the difference between actual and trend figures. An average of the seasonal variations for each
time period within the cycle must be determined and then adjusted so that the total of the seasonal variations sums to
zero.

Seasonal variation = actual sales – trend

Forecast sales = Trend + Seasonal variation

Multiplicative model

In this model, each actual figure is expressed as a proportion of the trend.

Seasonal variation = actual sales / trend

Forecast = Trend * Seasonal variation

Example
Example

Example