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Continue your assessment of cost function estimation methods by using the Netflix and Blockbuster Financial Data spreadsheet and the ideas generated in this week's class

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Continue your assessment of cost function estimation methods by using the Netflix and Blockbuster Financial Data spreadsheet and the ideas generated in this week's class discussion to develop cost function estimates for both Netflix and Blockbuster using the following methods:

Account classification

High-low

Regression analysis methods

Which method do you feel best estimates cost functions for both Netflix and Blockbuster? Why?

image text in transcribed NETFLIX INC Netflix quarterly operat ing results QUARTERLY OPERATING RESULTS (000 omitted) 2001.1 2001.3 2001.4 2002.1 2002.2 2002.3 2002.4 2003.1 2003.2 2003.3 2003.4 2004.1 2004.2 2004.3 2004.4 2005.1 2005.2 2005.3 2005.4 2006.1 2006.2 2006.3 2006.4 $17,057 $17,392 $18,444 $21,362 $30,069 $35,608 $40,163 $44,978 $55,281 $63,071 $71,278 $80,780 $99,823 $119,710 $140,414 $140,664 $152,446 $164,027 $172,740 $193,000 $224,126 $239,351 $255,950 $277,233 COSTS AND EXPENSES: Cost of revenues -Subscription costs . . . . . . . . . . . . . . . . . . . . . . . 18,177 Fulfillment costs . . . . . . . . . . . . . . . . . . . . . . . . 3,613 Gain on disposal of DVDs . . . . . . . . . . . . . . . . . . 0 Total cost of revenues . . . . . . . . . . . . . . . . . . . . 21,790 Technology and development expenses . . . . . . . . . . . 5,474 Marketing expenses . . . . . . . . . . . . . . . . . . . . . . . . . 6,653 General and administrative expenses . . . . . . . . . . . . . . .1,514 Total costs and expenses . . . . . . . . . . . . . . . . . . . . 35,431 OPERATING INCOME (LOSS) . . . . . . . . . . . . . . . . ($18,374) SELECTED SUBSCRIBER DATA (000 omitted) Subscriber additions during period . . . . . . . . . . . . . . . Subscriber cancellations during period . . . . . . . . . . . . Total subscribers at end of period . . . . . . . . . . . . . . . na na na $300,000 $250,000 10,776 3,589 (521) 13,844 4,896 4,090 1,031 23,861 9,667 3,283 (258) 12,692 4,463 3,444 1,003 21,602 10,468 2,967 (59) 13,376 2,901 6,844 1,110 24,231 14,872 4,155 (172) 18,855 3,181 7,938 1,309 31,283 17,779 4,854 (439) 22,194 3,518 8,054 1,638 35,404 21,147 4,908 (219) 25,836 3,966 9,299 1,870 40,971 23,246 5,449 (66) 28,629 3,960 10,492 1,920 45,001 29,928 6,383 (309) 36,002 4,183 13,207 2,248 55,640 35,148 7,221 (23) 42,346 4,123 9,957 2,093 58,519 38,326 8,322 (602) 46,046 4,738 12,183 2,678 65,645 44,334 9,348 (275) 53,407 4,840 14,602 2,566 75,415 56,444 10,790 (364) 66,870 5,039 26,693 3,136 101,738 69,604 14,373 (427) 83,550 5,652 20,477 3,280 112,959 71,130 15,013 (759) 85,384 6,325 22,525 4,122 118,356 76,223 16,433 (1,010) 91,646 5,890 28,332 5,749 131,617 93,986 16,694 (695) 109,985 7,155 35,803 5,007 157,950 99,957 17,560 (116) 117,401 7,513 26,338 4,898 156,150 97,878 17,544 (388) 115,034 8,006 32,867 8,020 163,927 101,967 18,964 (788) 120,143 8,268 46,989 11,470 186,870 126,220 22,045 (1,387) 146,878 11,206 52,968 8,292 219,344 128,605 21,974 (964) 149,615 12,043 47,031 6,773 215,462 135,210 23,583 (1,142) 157,651 11,929 59,367 9,948 238,895 142,586 26,762 (1,304) 168,044 13,201 66,158 11,142 258,545 ($6,469) ($3,158) ($2,869) ($1,214) $204 ($808) ($23) ($359) $4,552 $5,633 $5,365 ($1,915) $6,751 $22,058 $9,047 ($5,504) $7,877 $8,813 $6,130 $4,782 $23,889 $17,055 $18,688 $50,000 88 na 308 107 (81) 334 566 (444) 456 312 (165) 603 236 (169) 670 277 (205) 742 315 (200) 857 417 (222) 1,052 327 (232) 1,147 383 (239) 1,291 444 (248) 1,487 760 (315) 1,932 583 (422) 2,093 590 (454) 2,229 783 (402) 2,610 945 (537) 3,018 707 (529) 3,196 921 (525) 3,592 1,156 (569) 4,179 1,377 (690) 4,866 1,070 (767) 5,169 1,310 (817) 5,662 1,493 (839) 6,316 $0 $200,000 $150,000 Netflix re Netflix op $100,000 ($50,000) 2001.1 2001.2 2001.3 2001.4 2002 .1 2002 .2 2002.3 2002 .4 2003.1 2003.2 2003.3 2003.4 2004.1 2004.2 2004.3 2004.4 2005.1 2005.2 2005.3 2005.4 2006.1 2006.2 2006.3 2006.4 SUBSCRIPTION REVENUES . . . . . . . . . . . . . . . . . . 2001.2 tflix revenues tflix operating income NETFLIX INC. INCOME STATEMENTS ($000 omitted) Years ended 12/31/01 12/31/02 12/31/03 12/31/04 12/31/05 12/31/06 REVENUES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $74,255 $150,818 $270,410 $500,611 $682,213 $996,660 COSTS AND EXPENSES: Cost of revenues -Subscription . . . . . . . . . . . . . . . . . . . . . . . Fulfillment . . . . . . . . . . . . . . . . . . . . . . . . . Gain on disposal of DVDs . . . . . . . . . . . . . . . Total cost of revenues . . . . . . . . . . . . . . . . . Technology and development . . . . . . . . . . . . . . . Marketing . . . . . . . . . . . . . . . . . . . . . . . . . . . General and administrative . . . . . . . . . . . . . . . . Total costs and expenses . . . . . . . . . . . . . . . . . 49,088 14,930 (838) 63,180 19,212 22,509 6,136 111,037 77,044 21,602 (896) 97,750 16,861 38,019 8,973 161,603 147,736 34,358 (1,209) 180,885 20,968 53,033 12,669 267,555 273,401 58,311 (2,560) 329,152 29,467 100,534 22,104 481,257 393,788 71,987 (1,987) 463,788 35,388 144,562 35,486 679,224 532,621 94,364 (4,797) 622,188 48,379 225,524 36,155 932,246 OPERATING INCOME (LOSS) . . . . . . . . . . . . . . . . ($36,782) ($10,785) $2,855 $19,354 $2,989 $64,414 PER DOLLAR OF REVENUE REVENUES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 COSTS AND EXPENSES: Total cost of revenues . . . . . . . . . . . . . . . . . . . Technology and development . . . . . . . . . . . . . . . Marketing . . . . . . . . . . . . . . . . . . . . . . . . . . . General and administrative . . . . . . . . . . . . . . . . Total costs and expenses . . . . . . . . . . . . . . . . . 0.85 0.26 0.30 0.08 1.50 0.65 0.11 0.25 0.06 1.07 0.67 0.08 0.20 0.05 0.99 0.66 0.06 0.20 0.04 0.96 0.68 0.05 0.21 0.05 1.00 0.62 0.05 0.23 0.04 0.94 OPERATING INCOME (LOSS) . . . . . . . . . . . . . . . . (0.50) (0.07) 0.01 0.04 0.00 0.06 EST AVG MONTHLY PRICE (P) . . . . . . . . . . . . . . . . 4.13 8.38 15.02 13.91 14.21 11.87 EST AVG MONTHLY SUBSCRIPTIONS (Q) . . . . . . . . . .1,500 1,500 1,500 3,000 4,000 7,000 NETFLIX INC COSTS AS A FUNCTION OF SUBSCRIBER COUNTS F V Subscription costs . . . . . . . . . . . . . . . . . 7401.52 23.89 Fulfillment costs . . . . . . . . . . . . . . . . . . 3003.71 3.96 Gain on disposal of DVDs . . . . . . . . . . . . . -121.78 -0.18 10283.45 27.67 Total cost of revenues . . . . . . . . . . . . . . . Technology and development exp . . . . . . . 2605.43 1.62 Marketing expenses . . . . . . . . . . . . . . . . . 1119.78 10.03 General and administrative exp . . . . . . . . . . Total costs and expenses . . . . . . . . . . . . 410.30 1.71 14418.96 41.03 DATA SET . . . . . . . . . . . . . . . . SUBSCRIBERS AND SUBSCRIPTION REVENUE Subscriber count Quarter 2001.1 . Subscriber additions . Subscribers cancelled Subscribers cancelled % . . . . Avg fee per month Subscription costs Fulfillment costs Gain on DVD sales Cost of revenues Tech and dev exp Marketing expenses Genl and admin exp Total costs and exp 17,057 18,177 3,613 0 21,790 5,474 6,653 1,514 35,431 18.82 17,392 10,776 3,589 (521) 13,844 4,896 4,090 1,031 23,861 19.5% 19.15 18,444 9,667 3,283 (258) 12,692 4,463 3,444 1,003 21,602 444 49.3% 18.03 21,362 10,468 2,967 (59) 13,376 2,901 6,844 1,110 24,231 312 165 21.5% 18.93 30,069 14,872 4,155 (172) 18,855 3,181 7,938 1,309 31,283 35,404 2001.2 308 88 2001.3 334 107 81 2001.4 456 566 2002.1 603 . COSTS AND EXPENSES Subscription revenues 2002.2 670 236 169 20.1% 18.65 35,608 17,779 4,854 (439) 22,194 3,518 8,054 1,638 2002.3 742 277 205 21.6% 18.96 40,163 21,147 4,908 (219) 25,836 3,966 9,299 1,870 40,971 2002.4 857 315 200 18.9% 18.75 44,978 23,246 5,449 (66) 28,629 3,960 10,492 1,920 45,001 2003.1 1,052 417 222 17.4% 19.31 55,281 29,928 6,383 (309) 36,002 4,183 13,207 2,248 55,640 2003.2 1,147 327 232 16.8% 19.12 63,071 35,148 7,221 (23) 42,346 4,123 9,957 2,093 58,519 2003.3 1,291 383 239 15.6% 19.49 71,278 38,326 8,322 (602) 46,046 4,738 12,183 2,678 65,645 2003.4 1,487 444 248 14.3% 19.39 80,780 44,334 9,348 (275) 53,407 4,840 14,602 2,566 75,415 2004.1 1,932 760 315 14.0% 19.46 99,823 56,444 10,790 (364) 66,870 5,039 26,693 3,136 101,738 112,959 2004.2 2,093 583 422 16.8% 19.83 119,710 69,604 14,373 (427) 83,550 5,652 20,477 3,280 2004.3 2,229 590 454 16.9% 21.66 140,414 71,130 15,013 (759) 85,384 6,325 22,525 4,122 118,356 2004.4 2,610 783 402 13.3% 19.38 140,664 76,223 16,433 (1,010) 91,646 5,890 28,332 5,749 131,617 2005.1 3,018 945 537 15.1% 18.06 152,446 93,986 16,694 (695) 109,985 7,155 35,803 5,007 157,950 2005.2 3,196 707 529 14.2% 17.60 164,027 99,957 17,560 (116) 117,401 7,513 26,338 4,898 156,150 2005.3 3,592 921 525 12.8% 16.97 172,740 97,878 17,544 (388) 115,034 8,006 32,867 8,020 163,927 2005.4 4,179 1,156 569 12.0% 16.56 193,000 101,967 18,964 (788) 120,143 8,268 46,989 11,470 186,870 2006.1 4,866 1,377 690 12.4% 16.52 224,126 126,220 22,045 (1,387) 146,878 11,206 52,968 8,292 219,344 2006.2 5,169 1,070 767 12.9% 15.90 239,351 128,605 21,974 (964) 149,615 12,043 47,031 6,773 215,462 2006.3 5,662 1,310 817 12.6% 15.75 255,950 135,210 23,583 (1,142) 157,651 11,929 59,367 9,948 238,895 2006.4 6,316 1,493 839 11.7% 15.43 277,233 142,586 26,762 (1,304) 168,044 13,201 66,158 11,142 258,545 . BLOCKBUSTER INC. QUARTERLY OPERATING RESULTS (000 omitted) 2001.1 2001.2 2001.3 2001.4 2002.1 2002.2 2002.3 2002.4 2003.1 2003.2 2003.3 2003.4 2004.1 2004.2 2004.3 2004.4 2005.1 2005.2 2005.3 2005.4 2006.1 2006.2 2006.3 2006.4 REVENUES: Rental revenues . . . . . . . . . . . . . . . . . . . . . . . . . . $1,117,900 $1,034,700 $1,083,300 $1,078,800 $1,110,100 $1,064,700 $1,123,200 $1,162,400 $1,195,500 $1,095,100 $1,096,000 $1,146,900 $1,151,000 $1,076,000 $1,054,600 $1,147,000 $1,105,300 $1,020,400 $1,039,500 $1,040,000 $1,064,300 $990,200 $997,600 $978,000 Merchandise sales . . . . . . . . . . . . . . . . . . . . . . . . 169,500 157,100 152,900 255,700 193,700 190,300 238,100 397,600 298,900 275,100 263,800 443,800 330,900 323,200 333,000 545,500 425,900 360,400 327,700 472,500 349,100 314,300 315,800 453,000 Other revenues . . . . . . . . . . . . . . . . . . . . . . . . . . 20,500 34,200 28,500 23,600 22,200 16,000 25,200 22,400 23,400 22,000 24,700 26,500 21,200 22,000 22,400 26,400 17,700 17,800 19,100 18,100 16,000 14,000 15,900 15,300 Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,307,900 1,226,000 1,264,700 1,358,100 1,326,000 1,271,000 1,386,500 1,582,400 1,517,800 1,392,200 1,384,500 1,617,200 1,503,100 1,421,200 1,410,000 1,718,900 1,548,900 1,398,600 1,386,300 1,530,600 1,429,400 1,318,500 1,329,300 1,446,300 Cost of rental revenues . . . . . . . . . . . . . . . . . . 393,500 365,900 682,400 382,700 374,300 368,600 382,300 388,600 383,800 329,600 311,600 337,100 324,700 297,500 294,800 333,700 357,400 343,300 346,100 365,100 362,300 349,000 349,600 339,500 Cost of merchandise sold . . . . . . . . . . . . . . . . . 135,200 120,700 136,800 203,500 153,200 148,800 202,500 340,400 247,900 219,400 203,300 357,100 254,800 252,300 253,400 430,200 327,700 284,500 249,700 373,300 264,800 231,800 229,900 348,800 Total cost of revenues . . . . . . . . . . . . . . . . . . . 528,700 486,600 819,200 586,200 527,500 517,400 584,800 729,000 631,700 549,000 514,900 694,200 579,500 549,800 548,200 763,900 685,100 627,800 595,800 738,400 627,100 580,800 579,500 688,300 Selling, general and administrative . . . . . . . . . . . . . . COSTS AND EXPENSES: Cost of revenues -- 618,700 621,000 655,900 636,300 623,200 624,700 659,700 728,700 675,700 676,300 704,000 748,300 739,100 734,600 783,500 835,400 878,400 761,100 787,300 629,300 731,300 688,900 695,500 639,300 Depreciation, amortization, impairments . . . . . . . . . . . 106,700 Total costs and expenses . . . . . . . . . . . . . . . . . . . . 1,254,100 102,200 1,209,800 107,100 1,582,200 107,700 1,330,200 55,900 1,206,600 56,900 1,199,000 62,000 1,306,500 59,000 1,516,700 61,700 1,369,100 61,600 1,286,900 66,000 1,284,900 1,371,100 2,813,600 59,600 1,378,200 60,500 1,344,900 1,566,600 2,898,300 67,400 1,666,700 57,500 1,621,000 68,200 1,457,100 405,900 1,789,000 56,100 1,423,800 51,300 1,409,700 55,200 1,324,900 52,400 1,327,400 54,800 1,382,400 OPERATING INCOME (LOSS) . . . . . . . . . . . . . . . . . . . . $53,800 $16,200 ($317,500) $27,900 $119,400 $72,000 $80,000 $65,700 $148,700 $105,300 $99,600 ($1,196,400) $124,900 $76,300 ($1,488,300) $52,200 ($72,100) ($58,500) ($402,700) $106,800 $19,700 ($6,400) $1,900 $63,900 Blockbuster quarterly operating results $1,500,000 $1,000,000 $500,000 ($1,000,000) ($1,500,000) ($2,000,000) Quarter 2006.4 2006.3 2006.2 2006.1 2005.3 2005.4 2005.2 2005.1 2004.4 2004.3 2004.2 2004.1 2003.4 2003.3 2003.2 2003.1 2002.4 2002.3 2002.2 2002.1 2001.4 2001.3 2001.2 ($500,000) 2001.1 $0 Total revenues Operating inc (loss) BLOCKBUSTER INC. INCOME STATEMENTS ($000 omitted) Years ended 12/31/01 12/31/02 12/31/03 12/31/04 12/31/05 12/31/06 $4,314,700 735,200 106,800 5,156,700 $4,460,400 1,019,700 85,800 5,565,900 $4,533,500 1,281,600 96,600 5,911,700 $4,376,100 1,465,100 91,300 5,932,500 $4,160,300 1,488,800 72,200 5,721,300 $4,030,100 1,432,200 61,200 5,523,500 1,824,500 596,200 2,420,700 220,400 2,311,500 246,600 0 177,100 5,376,300 1,513,800 844,900 2,358,700 249,200 2,387,100 232,100 0 1,700 5,228,800 1,362,100 1,027,700 2,389,800 179,400 2,624,900 255,500 1,304,900 2,400 6,756,900 1,237,600 1,141,100 2,378,700 253,900 2,791,500 247,300 1,502,700 0 7,174,100 1,399,100 1,164,900 2,564,000 252,700 2,724,100 226,600 341,900 0 6,109,300 1,400,400 1,075,300 2,475,700 154,300 2,600,700 208,600 5,100 0 5,444,400 OPERATING INCOME (LOSS) . . . . . . . . . . . . . . . . ($219,600) $337,100 ($845,200) ($1,241,600) ($388,000) $79,100 REVENUES: Rental revenues . . . . . . . . . . . . . . . . . . . . . . Merchandise sales . . . . . . . . . . . . . . . . . . . . Other revenues . . . . . . . . . . . . . . . . . . . . . . Total revenues . . . . . . . . . . . . . . . . . . . . . . COSTS AND EXPENSES: Cost of revenues -Cost of rental revenues . . . . . . . . . . . . . . . Cost of merchandise sold . . . . . . . . . . . . . . Total cost of revenues . . . . . . . . . . . . . . . . Advertising . . . . . . . . . . . . . . . . . . . . . . General and administrative . . . . . . . . . . . . . . . Depreciation . . . . . . . . . . . . . . . . . . . . . . Long-lived asset impairments . . . . . . . . . . . . . Amortization of intangibles . . . . . . . . . . . . . . . Total costs and expenses . . . . . . . . . . . . . . . . PER DOLLAR OF REVENUE REVENUES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 COSTS AND EXPENSES: Total cost of revenues . . . . . . . . . . . . . . . . . . . Advertising . . . . . . . . . . . . . . . . . . . . . . General and administrative . . . . . . . . . . . . . . . Depreciation . . . . . . . . . . . . . . . . . . . . . . Long-lived asset impairments . . . . . . . . . . . . . Amortization of intangibles . . . . . . . . . . . . . . . Total costs and expenses . . . . . . . . . . . . . . . . . 0.47 0.04 0.45 0.05 0.00 0.03 1.04 0.42 0.04 0.43 0.04 0.00 0.00 0.94 0.40 0.03 0.44 0.04 0.22 0.00 1.14 0.40 0.04 0.47 0.04 0.25 0.00 1.21 0.45 0.04 0.48 0.04 0.06 0.00 1.07 0.45 0.03 0.47 0.04 0.00 0.00 0.99 (0.04) 0.06 (0.14) (0.21) (0.07) 0.01 OPERATING INCOME (LOSS) . . . . . . . . . . . . . . . . Gabrielle Corwin Week 2 Application 1 Application 1: Analyzing Pricing Decisions for Netflix and Blockbuster Develop simple cost-volume-profit models for Netflix and Blockbuster. NETFLIX - COST-VOLUME-PROFIT MODEL (REGRESSION) Revenues Costs Operating Income 350,000.00 300,000.00 250,000.00 200,000.00 150,000.00 100,000.00 50,000.00 (50,000.00) 0 1,000 2,000 3,000 4,000 5,000 6,000 What is the unit volume break-even level of Netflix? Based on the regression model above, break-even volume is 782 units. = 11,832.75 + 44.43 14,418.96 41.03 = 0 3.31 = 2,586.22 = = 782 7,000 Gabrielle Corwin Week 2 Application 1 With the data found in the Excel spreadsheet handout, Netflix's revenues, costs, and profits are: NETFLIX - ACTUAL REVENUES/COST Subscription revenues Total costs and exp Operating Income 300,000 250,000 200,000 150,000 100,000 50,000 0 (50,000) 0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 In both of the graphs, the operating income of Netflix increases as the subscriptions increase. What is the break-even revenue level of Blockbuster? With the data found in the Excel spreadsheet handout: Total Costs as a function of Total Revenues F V -513948.46 1.43 Total Costs = 0 (513948.46 + 1.43 ) = 0 0.43 = 513,948.46 = $1,196,050.07 How can Netflix and Blockbuster achieve profits equal to 10% of revenues? = 10% Netflix: 11,832.75 + 44.34 14,418.96 41.03 = 10% (11,832.75 + 44.34) 2,586.22 + 3.31 = 1,183.27 + 4.43 . = , . No solution. Based on the regression model, Netflix cannot achieve profits equal to 10% of revenues. But, based on the actual results, when the subscription count is at 5,169, the profit is 10% of revenues. Blockbuster: (513,948.46 + 1.43 ) = 10% 52.97% = 513,948.46 = $, . Gabrielle Corwin Week 2 Application 1 How can Blockbuster improve profitability given the CVP model? Given the CVP model, Blockbuster can improve profitability by investigating why depreciation, amortization, and impairment expenses are not consistent and expand rapidly at certain periods. What conditions would allow Netflix to increase price, and how would that affect profits? Netflix could increase price under the conditions that it improves its customer service and technology quality. Investing in more research and development on these ends would give Netflix the cause to increase prices on monthly subscriptions. With the investment in customer service and technology, Netflix's revenues will increase over its costs, meaning it will attract more subscribers, or increase its prices while maintaining the same amount of subscriptions, which will also increase profits in the long-run. A primer on cost function estimation There are three basic cost function estimation methods commonly used in product costing systems: (1) the account classification method (sometimes called the account analysis method); (2) the highlow method; and (3) the regression analysis method. Account classification method The account classification method of cost function estimation requires an assumption to be made about whether the cost is either a fixed cost or a variable cost. Such an assumption is presumably made by considering the nature of the cost (i.e., considering whether one would expect the cost to be fixed or variable) and examining recent accounting data in conjunction with some measure of production activity (e.g., unit production volume). If a cost is assumed to be fixed, then the cost function is simply estimated based on historical amounts, usually with some adjustment for price level increases. For example, insurance costs on a firm's manufacturing building and underlying land might be assumed to be fixed (with a zero variable cost component) and estimated based on prior year amounts adjusted for the expected increase in insurance premium rates: C ACt FACt VACt Qt FACt 1 (1 i) , 0 where Ct denotes insurance costs for year t, Ft denotes the costs are considered fixed within the year, and ft 1 (1 i) denotes last year's insurance cost adjusted for a rate increase of i. If the cost is assumed to be variable, then the cost function is estimated as C AC (Q) FAC VAC Q C ... C n . 0 1 Q Q1 ... Qn This cost function estimation method can be better understood and remembered by looking at a graph showing an example of such an estimated cost function: Account analysis estimation method Total costs 200 100 0 2010 Malcolm J. McLelland 500 Units produced and sold 1000 (Revised 18 October 2010) Notice that the linear cost function estimated using the account classification method (i) has a vertical axis intercept of zero, which makes sense since FAC 0 by assumption; and (ii) the function passes through the bivariate average of costs and units produced, (C , Q) . In this context, the graph above suggests a major drawback to using the account classification method for estimating cost functions: it generally does not capture the estimated value of any fixed costs implied by the actual historical data. As we will discuss further in the chapter on \"Cost control analysis\

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