CHAPTER 3

COST BEHAVIOUR
DISCUSSION QUESTIONS

1. Knowledge of cost behaviour allows a altered quickly. In the short run, resource
manager to assess changes in costs that expenditure is also independent of actual
result from changes in activity. This allows a activity usage. Salaries of engineers are an
manager to examine the effects of choices example of such an expenditure.
that change activity. For example, if excess
6. The concept of relevant range is important in
capacity exists, accepting bids that at least
cover variable costs may be totally dealing with step costs because if the
appropriate. Knowing what costs are variable relevant range is contained completely within
one step, the cost behaves as a fixed cost.
and what costs are fixed can help a manager
make better bids and, ultimately, better However, if the relevant range spans two or
business decisions. more steps, the accountant must be aware of
the cost increase as output goes up within the
2. A driver is a factor that causes or leads to a relevant range.
change in a cost or activity; it is an output 7. Mixed costs are usually reported in total in the
measure. The driver for general machine accounting records. How much of the cost is
maintenance cost in a factory could be
fixed and how much is variable is unknown
machine hours. The driver for raw materials and must be estimated.
used is the number of units produced.
8. The cost formula for a strictly fixed cost has
3. The cost formula for monthly shipping cost is: only a fixed cost amount. There is no variable
Monthly shipping cost = $3,560 + $6.70 rate and no independent variable. For the
(Packages shipped) depreciation example, the cost formula looks
like this:
The independent variable is packages
shipped. The dependent variable is monthly Depreciation per year = $15,000
shipping cost. The fixed cost per month is 9. The cost formula for a strictly variable cost
$3,560. The variable rate is $6.70. has only the variable rate and independent
4. Some account categories are primarily fixed variable. There is no fixed component. For
or variable. Even if the cost is mixed, either the electrical power example, the cost
the fixed component or the variable formula looks like this:
component is relatively small. As a result, Electrical power = $1.15 x (Machine hours)
assigning all of the cost to either a fixed or
variable category is unlikely to result in large 10. A scattergraph allows a visual portrayal of the
errors. For example, depreciation on relationship between cost and activity. It
property, plant, and equipment is largely reveals to the investigator whether a
fixed. The cost of telephone expense for the relationship may exist and, if so, whether a
sales office, if it consisted primarily of long- linear function can be used to approximate
distance calls, could be seen as largely the relationship.
variable (variable with respect to the number
of customers). 11. Managers can use their knowledge of the
cost relationships to estimate the fixed and
5. Committed fixed costs are those incurred for variable components. A scattergraph can be
the acquisition of long-term activity capacity used as an aid in this process. From a
and are not subject to change in the short run. scattergraph, a manager can select two
Annual resource expenditure is independent points that best represent the relationship.
of actual activity usage. For example, the These two points can then be used to derive
cost of a factory building is a committed fixed a linear cost formula. The high-low method
cost. Discretionary fixed costs are those tells the manager which two points to select
incurred for the acquisition of short-term to compute the linear cost formula. The
activity capacity, the levels of which can be

Copyright © 2018 by Nelson Education Ltd. 3-1

 selection of the two points is not left to best fits the data points. The method also
judgment. provides a measure of goodness of fit so that
the strength of the relationship between cost
12. Because the scattergraph method is not
and activity can be assessed.
restricted to the high and low points, it is
possible to select two points that better 14. The best-fitting line is the one that is “closest”
represent the relationship between activity to the data points. This is usually measured
and costs, producing a better estimate of by the line that has the smallest sum of
fixed and variable costs. The main advantage squared deviations.
of the high-low method is that it removes
15. The coefficient of determination is the
subjectivity from the choice process. The
percentage of total variability in costs
same line will be produced by two different
explained by activity. As such, it is a measure
people.
of goodness of fit, the strength of the
13. Assuming that the scattergraph reveals that relationship between cost and activity.
a linear cost function is suitable, then the
method of least squares selects a line that

3-2 Copyright © 2018 by Nelson Education Ltd.

 CORNERSTONE EXERCISES

Cornerstone Exercise 3–1

1. The cost formula takes the following form:

Total cost = Fixed cost + (Variable rate × Number of flash drives)
The monthly fixed cost is $18,000 (the combined $15,000 cost of equipment
depreciation and $3,000 cost of advertising), as it does not vary according to
the number of flash drives manufactured. The variable costs are materials and
manufacturing overhead, as both do vary with the number of flash drives
produced.
280,000 grams
Amount of materials per flash drive is = 56 grams per flash
5,000 flash drives
drive. The material cost per drive = $0.10 × 56 grams per drive = $5.60 per drive.
$22,500
Cost of manufacturing overhead per flash drive is = $4.50 per drive.
5,000
Therefore, the variable rate per flash drive is $5.60 + $4.50 = $10.10.
The cost formula is:
Total cost of flash drives = $18,000 + ($10.10 × Number of flash drives)
2. Expected fixed cost for next month is $18,000.
Expected variable cost for next month is $10.10 × 6,000 flash drives = $60,600.
Expected total manufacturing cost for next month is $18,000 + $60,600 =
$78,600.

Cornerstone Exercise 3–2

Step 1—Find the high and low points: The high number of employee hours is in
April, and the low number of employee hours is in August.

Step 2—Calculate the variable rate:

High point cost - Low point cost

Variable rate =
High employee hours - Low employee hours

$9,787 - $7,531 $2,256

= =
610 - 310 300

= $7.52 per employee hour

Copyright © 2018 by Nelson Education Ltd. 3-3

Cornerstone Exercise 3–2 (Continued)
Step 3—Calculate the fixed cost:

Fixed cost = Total cost – (Variable rate × Employee hours)

Let’s choose the low point with total cost of $7,531 and employee hours of 310.

Fixed cost = $7,531 – ($7.52 × 310) = $7,531 – $2,331 = $5,200

(Hint: Check your work by computing fixed cost using the high point.)

Step 4—Construct a cost formula: If the variable rate is $7.52 per employee hour
and fixed cost is $5,200 per month, then the formula for total monthly labour cost
is:

Total labour cost = $5,200 + ($7.52 × Employee hours)

Cornerstone Exercise 3–3

1. Total variable labour cost = Variable rate × Employee hours

= $7.52* × 675
= $5,076

2. Total labour cost = Fixed cost + (Variable rate × Employee hours)

= $5,200* + ($7.52 × 675)
= $5,200 + $5,076
= $10,276

*Refer to the solution for Cornerstone Exercise 3–2 for a detailed explanation of
the computations for variable cost per unit ($7.52) and total fixed cost ($5,200).

3-4 Copyright © 2018 by Nelson Education Ltd.

Cornerstone Exercise 3–4

1. Total variable labour cost = Variable rate × Employee hours

= $7.52* × 4,000
= $30,080

2. There’s a trick here; the cost formula is for the month, but we are being asked
to budget labour cost for the year. So, we will need to multiply the fixed cost for
the month by 12 (the number of months in a year).
Total fixed labour cost = Fixed cost × 12 months in a year
= $5,200* × 12
= $62,400

3. Total labour cost = 12($5,200) + ($7.52 × 4,000)

= $62,400 + $30,080
= $92,480

*Refer to the solution for Cornerstone Exercise 3–2 for a detailed explanation of
the computations for variable cost per unit ($7.52) and total fixed cost ($5,200).

Cornerstone Exercise 3–5

1. The fixed cost and the variable rate are given directly by regression.
Fixed cost = $ 1,145
Variable rate = $13.82

2. The cost formula is:

Total labour cost = $1,145 + ($13.82 × Employee hours)

3. Budgeted labour cost = $1,145 + ($13.82 × 675) = $10,474

Copyright © 2018 by Nelson Education Ltd. 3-5

 EXERCISES

Exercise 3–6

a. Power to operate a drill (to drill holes in the wooden frames of the futons)—
Variable cost
b. Cloth to cover the futon mattress—Variable cost
c. Salary of the factory receptionist—Fixed cost
d. Cost of food and decorations for the annual Canada Day party for all factory
employees—Fixed cost
e. Fuel for a forklift used to move materials in the factory—Variable cost
f. Depreciation on the factory—Fixed cost
g. Depreciation on a forklift used to move partially completed goods—Fixed cost
h. Wages paid to workers who assemble the futon frame—Variable cost
i. Wages paid to workers who maintain the factory equipment—Fixed cost
j. Cloth rags used to wipe the excess stain off the wooden frames—Variable cost

Exercise 3–7
1.

Truck Depreciation

250,000
Depreciation Cost ($)

200,000

150,000

100,000

50,000

0
0 10 20 30 40 50 60 70 80 90 100

Cubic Metres of Cement

(in thousands)

3-6 Copyright © 2018 by Nelson Education Ltd.

Exercise 3–7 (Continued)

2.

Raw Materials Cost

3,000

2,500
Cost (in thousands $)

2,000

1,500

1,000

500

0
0 20 40 60 80 100

Cubic Metres of Cement (in thousands)

3. Truck depreciation—Fixed cost

Raw materials cost—Variable cost

Exercise 3–8

Variable Discretionary Committed

Cost Category
Cost Fixed Cost Fixed Cost
Technician salaries X
Laboratory facility X
Laboratory equipment X
Chemicals and other
supplies X

Copyright © 2018 by Nelson Education Ltd. 3-7

Exercise 3–9

1. Total maintenance cost = $460,000 + ($12.50 × 150,000) = $2,335,000

2. Total fixed maintenance cost = $460,000

3. Total variable maintenance cost = $12.50(150,000) = $1,875,000

$460,000  ($12.50  150,000)
4. Maintenance cost per unit =
150,000
$2,335,000
=
150,000
= $15.57

$460,000
5. Fixed maintenance cost per unit = = $3.07
150,000

6. Variable maintenance cost per unit = $12.50

Exercise 3–10

1. Total maintenance cost = $460,000 + ($12.50 × 80,000) = $1,460,000

2. Total fixed maintenance cost = $460,000

3. Total variable maintenance cost = $12.50(80,000) = $1,000,000

$460,000  ($12.50  80,000)

4. Maintenance cost per unit =
80,000
$1,460,000
=
80,000
= $18.25

$460,000
5. Fixed maintenance cost per unit = = $5.75
80,000

6. Variable maintenance cost per unit = $12.50

3-8 Copyright © 2018 by Nelson Education Ltd.

Exercise 3–11

1.

Machining Department
Direct Labour Cost
$350,000
Cost of Direct Labour 300,000
250,000
200,000
150,000
100,000
50,000
0
0 1,000 2,000 3,000 4,000 5,000
Number of Units

The direct labour cost in the machining department is a step cost (with narrow
steps).

2.

Machining Department
Supervision Cost

$150,000
Cost of Supervision

100,000

50,000

0
0 1,000 2,000 3,000 4,000 5,000

Number of Units

The cost of supervision for the machining department is a step cost (with wide
steps).

3. Direct labour cost increase = $144,000 – $108,000 = $36,000

Supervision increase = $80,000 – $40,000 = $40,000

Copyright © 2018 by Nelson Education Ltd. 3-9

Exercise 3–12

1. K
2. H
3. A
4. J
5. I
6. E

Exercise 3–13

1.

Cost of Giving Opening Shows

8,000
7,000
6,000
5,000
Cost ($)

4,000
3,000
2,000
1,000
0
0 5 10 15 20
Number of Opening Shows

This is a strictly variable cost.

3-10 Copyright © 2018 by Nelson Education Ltd.

Exercise 3–13 (Continued)
2. This is a strictly fixed cost.

Cost of Running the Gallery

100,000

80,000

60,000
Cost ($)

40,000

20,000

0
0 5 10 15 20
Number of Opening Shows

3. This is a mixed cost.

Ivan's Total Costs

88,000
87,000
86,000
85,000
Total Cost ($)

84,000
83,000
82,000
81,000
80,000
79,000
0 5 10 15 20
Number of Opening Shows

4. Total cost = $80,000 + ($500 × Number of opening shows)

5. Total cost = $80,000 + ($500 × 12) = $86,000

Total cost = $80,000 + ($500 × 14) = $87,000

Copyright © 2018 by Nelson Education Ltd. 3-11

Exercise 3–14

1. High Point March

Low Point January
High and low points are based on activity levels, not dollar amounts.

2. High Activity 6,200 visits

Low Activity 1,400 visits
High Cost $5,580
Low Cost $3,516
Difference in Visits 4,800
Difference in Cost $2,064
Variable Cost Per Visit $2,064/4,800 = $0.43
Fixed Cost Per Month $5,580 – (6,200 × 0.43) = $2,914

3. Formula: $2,914 + ($0.43 × Number of visits)

4. Cost for 5,000 visits: $2,914 + ($0.43 × 5,000) = $5,064

Fixed component: $2,914

Variable component: $0.43 × 5,000 = $2,150

3-12 Copyright © 2018 by Nelson Education Ltd.

Exercise 3–15

Scattergraph of Tanning Services
6000

5000
Monthly Cost ($)

4000

3000

2000

1000
0 1000 2000 3000 4000 5000 6000 7000
Number of Appointments

Scattergraph shows a linear relationship between cost and number of visits,

except for two outliers.

Exercise 3–16

1.
Coefficients
Intercept 2833.798259
X Variable 1 0.425711198

Cost formula: $2,833.80 + (0.4257 × Number of visits)

2. Cost for 5,000 visits: $2,833.80 + ($0.4257 × 5,000) = $4,962.30

Copyright © 2018 by Nelson Education Ltd. 3-13

Exercise 3–17

1. Variable Rate for Depreciation: High amount $2,800,000

Low amount $2,800,000
Difference in cost $0
Difference in volume 13,600,000
Variable amount 0
Variable rate 0
Fixed Amount $2,800,000

2. Cost Formula for Depreciation: $2,800,000 + (0 × Number of kilometres)

3. Variable Rate for Fuel: High amount $1,610,000

Low amount $1,134,000
Difference in cost $ 476,000
Difference in volume 13,600,000
Variable amount $ 476,000
Variable rate $0.035
Fixed Amount $0

4. Cost Formula for Fuel $0 + ($0.035 × Number of kilometres)

5. Variable Rate for Maintenance: High amount $1,797,200

Low amount $1,413,680
Difference in cost $ 383,520
Difference in volume 13,600,000
Variable amount $ 383,520
Variable rate $0.0282
Fixed Amount $ 500,000

6. Cost Formula for Maintenance $500,000 + ($0.0282 × Number of kilometres)

7. Depreciation: $2,800,000
Fuel: $0.035 × 36,000,000 = $1,260,000
Maintenance: $500,000 + (0.0282 × 36,000,000) = $1,515,200

8. A fixed cost remains the same when output changes, whereas a variable cost
changes in direct proportion to the change in output. A fixed cost is a stated
amount, such as $25,000, whereas a variable cost is stated as a cost per unit,
such as $35 per unit.

3-14 Copyright © 2018 by Nelson Education Ltd.

Exercise 3–18

1. Cost Formulas annually

Depreciation: 12 × $2,800,000= $33,600,000
Fuel: $0.035 × Number of kilometres
Maintenance: (12 × $500,000) + ($0.0282 × Number of kilometres)
2. Depreciation: $33,600,000
Fuel: $0.035 × 480,000,000 = $16,800,000
Maintenance: (12 × $500,000) + (0.0282 × 480,000,000) = $19,536,000

Exercise 3–19

1. Total cost of receiving = $106,327 + ($193 × Number of parts inspected)

2. Independent variable—number of parts inspected

Dependent variable—total cost of receiving
Variable rate—$193 per part inspected
Fixed cost per month—$106,327

3. Total cost of receiving = $106,327 + ($193 × 2,500) = $588,827

Exercise 3–20

1. Total annual cost of receiving

= 12($106,327) + ($193 × Number of parts inspected in a
year)
= $1,275,924 + ($193 × Number of parts inspected in a year)

NOTE: Fixed and variable costs, based on monthly data, are computed in
Exercise 3–19.

2. Total annual cost of receiving = $1,275,924 + ($193 × 29,000) = $6,872,924

Copyright © 2018 by Nelson Education Ltd. 3-15

Exercise 3–21

1. Overhead cost Dependent variable

$109,743 Fixed cost (intercept)
$80.75 Variable rate (slope)
Direct labour hours Independent variable

2. Next month’s budgeted overhead cost = $109,743 + ($80.75 × 5,000)

= $513,493
3. Next quarter’s budgeted overhead cost = (3 × $109,743) + ($80.75 × 18,000)
= $329,229 + $1,453,500
= $1,782,729
4. Next year’s budgeted overhead cost = (12 × $109,743) + ($80.75 × 58,000)
= $1,316,916 + $4,683,500
= $6,000,416
Exercise 3–22

1.
Intercept 43155.93
Slope 9.2312
R Squared 0.9150

2. Overhead cost = $43,156 + ($9.23 × Number of direct labour hours)

3. The R2 is 0.915, or 91.5 percent. Direct labour hours account for more than 91
percent of overhead cost. Thus, direct labour hours is a good predictor of
overhead cost. Another factor (or factors) accounts for the remaining 8.5
percent of overhead cost.

4. Overhead cost = $43,156 + ($9.23 × 1,450) = $56,540

3-16 Copyright © 2018 by Nelson Education Ltd.

Exercise 3–23

1.
Intercept 942
Slope 1.79
R Squared 0.841

2. Delivery cost = $942 + ($1.79 × Number of deliveries)

3. The R2 is 0.841, or 84.1 percent. Number of deliveries accounts for slightly more
than 84 percent of delivery cost. This is not bad. Another factor (or factors)
accounts for just under 16 percent of delivery cost.

4. Delivery cost = $942 + ($1.79 × 300) = $1,479

Copyright © 2018 by Nelson Education Ltd. 3-17

 PROBLEMS

Problem 3–24

1. Mixed cost

2. Fixed cost

3. Mixed cost

4. Step cost

5. Variable cost

6. Variable cost

7. Variable cost

8. Fixed cost until the minimum is reached, then mixed cost

Problem 3–25

a. This must be the high-low method because she has only two data points (one
for each year).

b. This is the method of least squares done on a personal computer. While it is

possible to use a personal computer to do the other methods, it is unlikely that
Francis would have gone to all the trouble of entering 60 months of data simply
to use the high-low method.

c. Ron is making a scattergraph.

d. In all probability, Rikki is using the high-low method. She can do this quickly
and get some rough results in time for her meeting.

Problem 3–26

1. Variable cost 6. Variable cost

2. Committed fixed cost 7. Variable cost
3. Discretionary fixed cost 8. Discretionary fixed cost
4. Discretionary fixed cost 9. Discretionary fixed cost
5. Discretionary fixed cost 10. Variable cost

3-18 Copyright © 2018 by Nelson Education Ltd.

Problem 3–27

1.

50,000
45,000
40,000
35,000
30,000
Cost ($)

25,000
20,000
15,000
10,000
5,000
0
0 500 1,000 1,500 2,000
Receiving Orders

Yes, the relationship appears to be reasonably linear.

2. Using the high-low method:

$40,500 - $22,500
Variable receiving cost = = $18
1,700 - 700
Fixed receiving cost = $40,500 – $18(1,700) = $9,900
Predicted cost for 1,450 receiving orders:
Receiving cost = $9,900 + $18(1,450) = $36,000

3. Receiving cost for a quarter = 3($9,900) + ($18 x Number of receiving orders)

Receiving cost for the quarter = 3($9,900) + $18(4,650)
= $29,700 + $83,700
= $113,400
Receiving cost for a year = 12($9,900) + ($18 x Number of receiving orders)

Receiving cost for the year = 12($9,900) + $18(18,000)

= $118,800 + $324,000
= $442,800

Copyright © 2018 by Nelson Education Ltd. 3-19

Problem 3–28

1. Receiving cost = $4,818+ ($22.73 × Number of receiving orders)

2. Receiving cost = $4,818 + ($22.73 × 1,450) = $37,777

3. Receiving cost for a quarter = 3($4,818) + ($22.73 x Number of receiving orders)

Receiving cost for the quarter = 3($4,818) + $22.73(4,650)
= $14,454 + $105,694.50
= $120,148.50
Receiving cost for a year = 12($4,818) + ($22.73 x Number of receiving orders)
Receiving cost for the year = 12($4,818) + $22.73(18,000)
= $57,816 + $409,140
= $466,956

Problem 3–29
1.
120 Hours ($) 150 Hours ($)

Salaries:
Senior accountant $4,500 $4,500 Fixed
Office assistant 1,800 1,800 Fixed
Internet and software subscriptions 700 850 Mixed
Consulting by senior partner 1,200 1,500 Variable
Depreciation (equipment) 2,400 2,400 Fixed
Pamphlets and promotion 600 700 Mixed
Supplies 905 1,100 Mixed
Administration 500 500 Fixed
Rent (offices) 2,000 2,000 Fixed
Utilities 332 365 Mixed

2.
Internet etc. ($100 + $5 per hour)
Pamphlets and promotion ($200 + $3.33 per hour)
Supplies ($125 + $6.50 per hour)
Utilities ($200 + $1.10 per hour)

3.
Total fixed costs: ($4,500 + $1,800 + $100 + $2,400 + $200 + $125 + $500 +
$2,000 + $200) = $11,825
Variable costs: ($5 + $10 + $3.33 + $6.50 + $1.10) = $25.93 per hour

3-20 Copyright © 2018 by Nelson Education Ltd.

Problem 3–29 (Continued)
4. At 140 hours per month, total costs would be $11,825 + ($25.93 × 140 hours)
= $15,455.

Must charge out at $15,455/140 hours= $110.39 per hour

5. At 170 hours per month, total costs would be $11,825 + ($25.93 × 170) =
$16,233.
Must charge out at $16,233/170 hours = $95.49
The price declines as fixed costs are spread over more hours.

Problem 3–30

1. Committed resource charges: monthly fee, activation fee, cancellation fee (if
triggered by contract cancellation prior to one year)
Flexible resource charges: all additional charges for airtime, long distance, and
roaming

2. Plan 1:
Minutes available = Minutes used + Unused minutes
60 minutes = 45 minutes + 15 minutes

Plan 2:
Minutes available = Minutes used + Unused minutes
120 minutes = 45 minutes + 75 minutes

Plan 1 is more cost effective. Jana will have some unused capacity (on average,
15 minutes a month), and the overall cost will be lower by $10 per month.

3. Plan 1:*
Minutes available = Minutes used + Unused minutes
60 minutes = 90 minutes + (–30) minutes

Plan 1:*
Monthly minutes available = Minutes used + Unused minutes
60 minutes = 60 minutes + 0 minutes
Additional minutes = 30 minutes

*There are a number of ways to illustrate the use of minutes with Plan 1. Here are
two possibilities. The problem, of course, is that all included monthly minutes
are used and Jana must purchase additional minutes.

Copyright © 2018 by Nelson Education Ltd. 3-21

Problem 3–30 (Continued)

Plan 2:
Minutes available = Minutes used + Unused minutes
120 minutes = 90 minutes + 30 minutes

Plan 2 is now more cost effective, as the monthly cost is $30. Under Plan 1, Jana
will pay $20 plus $30 (30 minutes × $1) per month. (The $1 additional charge
includes the airtime and regional roaming charges.)

4. Results of students’ analyses will vary.

3-22 Copyright © 2018 by Nelson Education Ltd.

Problem 3–31

1. Variable costs—salary of the two paralegals times the percentage of time spent
in processing uncontested claims; salary of the accountant times the
percentage of time spent in this activity; cost of claims forms, cheques,
envelopes, and postage

Fixed costs—salaries of the two paralegals times the percentage of time spent
in handling contested claims, depreciation on office equipment used in claims
processing activity

2. The independent variable is number of claims processed; the dependent

variable is cost of claims processing.

3. The low point is March with $31,260 cost and 4,900 claims; the high point is
June with $44,895 cost and 7,930 claims.

$44,895 - $31,260
Variable rate =
7,930 - 4,900
$13,635
=
3,030
= $4.50 per claim

Using the high point:

Fixed cost = $44,895 – ($4.50 × 7,930) = $9,210
Total cost of claims processing = $9,210 + ($4.50 × Number of claims)

4. Cost of outsourcing = $4.60(75,600) = $347,760

Cost of processing in-house = 12($9,210) + $4.50(75,600)
= $110,520 + $340,200
= $450,720
Tiffany should outsource the claims processing for a savings of $102,960
($450,720 – $347,760).

Copyright © 2018 by Nelson Education Ltd. 3-23

Problem 3–32

1. The insurance premiums and the average cost per injury are fixed with respect
to the number of racquets sold. The insurance premiums are variable (to an
extent) with respect to the number of injury claims. That is, over a certain base
premium, the premium increases as the number of injuries increases. The
average cost per injury is variable with respect to the number of serious versus
nonserious injuries incurred. However, North Shore’s experience was that
serious injuries could be reduced through education and changes in dangerous
practices. The number of racquets sold was not relevant.

2. Yes, the safety program paid for itself. There was a $50,000 reduction in annual
cost of insurance premiums and a $22,000 reduction in the total cost of injuries
per year [$22,500 ($1,500 × 15) – $500 ($50 × 10)]. This is a monetary reduction
of $72,000 per year versus the $60,000 salary of the safety director. In addition,
the number of workdays lost went from 30 to 0, and the number of serious
injuries went from 4 to 0. While these reductions were not quantified (outside
the average injury cost), they are important and are considered a benefit of the
safety program.

3-24 Copyright © 2018 by Nelson Education Ltd.

Problem 3–33

1. Results of regressions:
10 Months’ Data 12 Months’ Data
Intercept ........................... 4,818 5,730
Slope ................................ 22.73 22.65
R2 ...................................... 0.8485 0.7451

2.

50,000
45,000
40,000
35,000
30,000
Cost ($)

25,000
20,000
15,000
10,000
5,000
0
0 500 1,000 1,500 2,000
Receiving Orders

The point for the 11th month (1,200 receiving orders and $42,000 total receiving
cost) appears to be an outlier. Since the cost was so much higher in this month
due to an event that is not expected to happen again, this data point could easily
be dropped. Then, data from the 11 remaining months could be used to develop
a cost formula for receiving cost.

Copyright © 2018 by Nelson Education Ltd. 3-25

Problem 3–33 (Continued)

3. Results for the method of least squares after dropping month 11.

Results of regression:
11 Months’ Data
Intercept ........................... 4,753
Slope ................................ 22.77
R2 ...................................... 0.8588

Receiving cost
= $4,753 + ($22.77 × Number of receiving orders)

Predicted receiving cost for a month

= $4,753 + ($22.77 × 1,450) = $37,770

The regression run on the 11 months of data from “typical” months appears to
be better than the one for all 12 months. R2 is higher for the regression without
the outlier (85.88 percent versus 74.51 percent), and the scattergraph gives
Tracy confidence that the data without the outlier describe a relatively linear
relationship. Since the storm damage is not expected to recur, month 11 can
safely be dropped from a regression meant to help predict future receiving cost.

3-26 Copyright © 2018 by Nelson Education Ltd.

Problem 3–34
1.

70,000

60,000

50,000
Power Cost ($)

40,000

30,000

20,000

10,000

0
0 5,000 10,000 15,000 20,000 25,000 30,000 35,000
Machine Hours

The overall relationship looks reasonably linear—although the data point for the
first quarter may be an outlier.

2. Using the high-low method:

$63,750 - $43,500
Variable power cost = = $1.69
30,000 - 18,000
Fixed power cost = $63,750 – ($1.69 × 30,000) = $13,050
Total power cost = $13,050 + ($1.69 × Number of machine hours)

3. Output of regression program:

Intercept 10,350
Slope 1.8136
R Squared .7981

Total power cost = $10,350 + ($1.81 × Number of machine hours)

R2 is 0.798, or 79.8 percent. This is not bad; however, a little more than 20
percent of the variance in the dependent variable (power cost) is not explained
by the independent variable (machine hours).

Copyright © 2018 by Nelson Education Ltd. 3-27

Problem 3–34 (Continued)

4. The output of a regression program after quarter 1 (20,000, $39,000) has been
dropped is shown below.

Intercept 18,611
Slope 1.5147
R Squared .9175
Total power cost = $18,611 + ($1.51 × Number of machine hours)

This regression looks better in terms of R2. The R2 for this regression is 0.918,
or 91.8 percent. By dropping the outlier, the explanatory power of machine
hours is much improved. However, the controller should first carefully examine
quarter 1 to see what the reason was for the lower than expected power cost. If
the explanation is that something occurred that is not expected to reoccur, then
the point can be dropped. If the reason is one that is expected to reoccur, then
that needs to be factored into the controller’s judgment about power costs.

3-28 Copyright © 2018 by Nelson Education Ltd.

Problem 3–35

1.

14,000

13,000

12,000
Delivery Cost ($)

11,000

10,000

9,000

8,000
0 4,000 8,000 12,000 16,000 20,000 24,000 28,000
Kilometres Driven

2. Intercept: 10,010; R2 is 0.706; Slope 0.0834

3. Cost formula: $10,010 + (0.08 x kilometres driven).

4. Will agree with scattergraph.

5. Responses will differ but the important thing is that the least-squares analysis
is more accurate.

Copyright © 2018 by Nelson Education Ltd. 3-29

Problem 3–36

1.

2,500

2,000
Cost $

1,500

1,000

500

0
0 50 100 150 200 250 300 350
Jobs

2.

Intercept 850
Slope 3.7828
R Squared .5190

Cost of Moving Materials is: $850 + ($3.78 x Number of Jobs)

Cost for 250 Jobs = $850 + ($3.78 x 250) = $850 + $945 = $1,795

3. Since the R Squared value is .5190, then the relation between the number of
moves and the cost only accounts for about 52% of the costs. This is very
poor. There may be other factors that are a better indicator of costs.

3-30 Copyright © 2018 by Nelson Education Ltd.

Problem 3-37

1.

250,000

200,000

150,000
Cost ($)

100,000

50,000

0
0 500 1,000 1,500 2,000 2,500 3,000 3,500
Activity

2. October, November, and December of Year 2.

3. Intercept 275
Slope 61.9433
R Squared .9824

Cost formula: $275 + ($61.94 x Number of activities)

Cost: $275 + ($61.94 x 2,000) = $124,155

4. Intercept 2,756.77
Slope 60.28
R Squared .9986

Cost Formula: $2,757 + ($60.28 x Number of activities)

Cost: $2,757 + ($60.28 x 2,000) =$123,317

5. With the elimination of the outliers, the solution is more accurate as can be
seen by the increase in the R2 value.

Copyright © 2018 by Nelson Education Ltd. 3-31

 PROFESSIONAL EXAMINATION PROBLEM*

Professional Examination Problem 3–38

1. Machine- Overhead
Hours Costs
High 25,000 99,000
Low 10,000 64,500
Change 15,000 34,500

Variable cost = $34,500 / 15,000 = $2.30

Fixed cost = $99,000 – (25,000 × $2.30) = $41,500

2. Economic plausibility criteria – is it reasonable to expect overhead

costs would vary with machine hours? Yes.

Goodness of fit criteria – the r2 = 91%. This means 91% of the

variation in overhead costs is explained by the variation in machine
hours. This is a good result.

Conclusion: the regression is acceptable.

3. Using the high-low method, the overhead equation is:

Overhead = $41,500 + 2.30*MH
The estimate of overhead costs at 22,000 machine hours is:
$41,500 + 2.30(22,000) = $92,100

Using regression analysis, the overhead equation is:

Overhead = $39,859 + 2.15*MH
The estimate of overhead costs at 22,000 machine hours is:
$39,859 + 2.15(22,000) = $87,159

* © CPA Ontario.

3-32 Copyright © 2018 by Nelson Education Ltd.

 CASES

Case 3–39

1. The order should cover the variable costs described in the cost formulas.
These variable costs represent flexible resources.
Materials ($94 × 20,000) $1,880,000
Labour ($16 × 20,000) 320,000
Variable overhead ($80 × 20,000) 1,600,000
Variable selling ($7 × 20,000) 140,000
Total additional resource spending $3,940,000
Divided by units produced ÷ 20,000
Total unit variable cost $ 197
Velocity should accept the order because it would cover total variable costs
and increase income by $15 per unit ($212 – $197), for a total increase of
$300,000.

2. The coefficients of determination indicate the reliability of the cost formulas.

Of the four formulas, overhead activity may be a problem. A coefficient of
determination of 0.56 means that only about 56 percent of the variability on
overhead cost is explained by direct labour hours. This should have a bearing
on the answer to Requirement 1 because if the percentage is low, there are
activity drivers other than direct labour hours that are affecting variability in
overhead cost. What these drivers are and how resource spending would
change need to be known before a sound decision can be made.

Copyright © 2018 by Nelson Education Ltd. 3-33

Case 3–39 (Concluded)

3. Resource spending attributable to order:

Materials ($94 × 20,000) $ 1,880,000
Labour ($16 × 20,000) 320,000
Variable overhead:
($85 × 20,000) 1,700,000
($5,000 × 12) 60,000
($300 × 600) 180,000
Variable selling ($7 × 20,000) 140,000
Total additional resource spending $ 4,280,000
Divided by units produced ÷ 20,000
Total unit variable cost $ 214
The order would not be accepted now because it does not cover the variable
activity costs. Each unit would lose $2 ($212 – $214).
It would also be useful to know the step-cost functions for any activities that
have resources acquired in advance of usage on a short-term basis. It is
possible that there may not be enough unused activity capacity to handle the
special order, and resource spending may also be affected by a need (which,
in this case, would be unexpected) to expand activity capacity.

3-34 Copyright © 2018 by Nelson Education Ltd.

Case 3–40
1. Cost formula(let x be the number of hours billed to clients):

Professional Staff
Partner: $100,000 + $100x + $50x + $10x
Senior Consultant: $75,000 + $50x + $6x + $10x
Junior Consultant: $60,000 + $10x + $2x + $10x
Fixed costs: $3,000,000 + $250,000 + $360,000

2. Costs at 1,500 hours billed by each professional:

= 3($100,000 + ($160 x 1,500)) + 12($75,000 + ($66 x 1,500)) + 30($60,000 +

($22 x 1,500)) + $3,610,000
= $300,000 + 3($240,000) + $900,000 + 12($99,000) + $1,800,000 +30($33,000)
+ $3,610,000
= $300,000 + $720,000 + $900,000 + $1,188,000 + $1,800,000 + $990,000 +
$3,610,000 = $9,508,000

Costs at 2,000 hours billed by each professional:

= 3($100,000 + ($160 x 2,000)) + 12($75,000 + ($66 x 2,000)) + 30($60,000 +

($22 x 2,000)) + $3,610,000
= $300,000 + 3($320,000) + $900,000 + 12($132,000) + $1,800,000 +
30($44,000) + $3,610,000
= $300,000 + $960,000 + $900,000 + $1,584,000 + $1,800,000 + $1,320,000 +
$3,610,000 = $10,474,000

Case 3–41

Bill finds himself in a difficult situation. All costing and bids for future business are
reliant on estimated costs. Changing the mix between fixed and variable costs in
the estimate may allow the company to enter a winning bid. However, the risk is
that the fixed costs will be much higher than his revised estimate and may put the
company in a precarious situation if it does not win bids on the subsequent phases.

The analysts must have complete and accurate information to make an informed
bid. To knowingly adjust the parameters of the costing information to make the bid
look more favourable is wrong. The decision must be made on the best information
available at the time that the bid is submitted.

Copyright © 2018 by Nelson Education Ltd. 3-35