Cost Behavior: Statistical Estimation

The Linearity Assumption and the Relevant Range

Exh. 5-4

A straight line Economists closely Curvilinear Cost approximates a Function curvilinear

Total Cost

Relevant Range

variable cost line within the relevant range.

Accountants Straight-Line Approximation (constant unit variable cost) Activity

The Linearity Assumption and the Relevant Range

Question: How do you interpret the intercept on the vertical axis?

Exh. 5-4

Total Cost

Activity

Estimating the cost function: High-low (two point) method Assume: Data: Obs. 1 Obs. 2 Y X Y 1,000 1,200 2,000 1,800 Y=a+bX

.X=2000, Y =1800 .X=1000, Y=1200

X Required: Estimate a linear cost function based on the two given observations.

b = Y / X = 600 / 1000 = .6 a = Y bX = 1,200 (.6)(1,000) = 600 Y = 600 + .6 X

Assume that a third observation is available as follows: X = 3,000, Y = 2,000. Based on the three available data points, estimate the cost function. Y

. X=3000, Y = 2000
.X=2000, Y =1800 .X=1000, Y=1200
X

Overhead Costs
Quarter
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

OH Costs
$9,891 $9,244 $13,200 $10,555 $9,054 $10,662 $12,883 $10,345 $11,217 $13,269 $10,830 $12,607 $10,871 $12,816 $8,464

RepairHours
248 248 480 284 200 380 568 344 448 544 340 412 384 404 212

Scattergraph
Plot of cost and activity levels
Manufacturing Overhead
$16,000 $14,000 $12,000

MOH Costs

$10,000 $8,000 $6,000 $4,000 $2,000 $0 0 100 200 300 Repair-Hours 400 500 600

A visual representation

Does it look like a relationship exists between repair-hours and overhead costs?

High-Low Cost Estimation

A method to estimate costs based on two cost observations, usually at the highest and lowest activity level.
Choose two data points. Use the two points to determine the line representing the costactivity relation. Draw a total cost line.
Repair-Hours

The highest and lowest activity.

3C Overhead

Overhead Costs
Quarter
1 2 3 4 5 6 7 8 9 10 11 12

OH Costs
$9,891 $9,244 $13,200 $10,555 $9,054 $10,662 $12,883 $10,345 $11,217 $13,269 $10,830 $12,607

RepairHours
248 248 480 284 200 380 568 344 448 544 340 412

13
14 15

$10,871
$12,816 $8,464

384
404 212

Use the high-low method to estimate the cost function.

Repair hours High (obs.7) Low (obs.5) Difference OH$ $12,883 $ 9,054 $ 3,829 RH 568 200 368

Slope: 3829 / 368 = $10.40 Intercept: $6,974

Regression
Statistical procedure to determine the relationship between variables. High-Low Method Uses two data points.

Regression

Uses all the data points.

3C Overhead

Regression Continued
The relationship between activities and costs
Independent variable: Repair-hours

Dependent variable: Overhead costs

The Regression Equation

Y = Y = OH = a

+ b X
+ +
Slope V X Repair-hours

Intercept Fixed costs

Excel output, Simple Linear Regression

Estimate 3Cs overhead with 520 repair hours.

Given the following regression estimates:

Total cost = $6,472 + (12.52) x (RH) = $6,472 + (12.52) x (520) = $12,982 SEE (Y) = $ 678.00 SE (B1) = $ 1.58

Given the following regression estimates:

Total cost = $6,472 + (12.52) x (RH) = $6,472 + (12.52) x (520) = $12,982 SEE (Y) = $ 678.00 SE (B1) = $ 1.58

(1)

Provide 95% confidence intervals around the estimate of total cost, and around the estimated variable overhead per hour of repair time.

Given the following regression estimates:

Total cost = $6,472 + (12.52) x (RH) = $6,472 + (12.52) x (520) = $12,982 SEE (Y) = $ 678.00 SE (B1) = $ 1.58

(1)

Provide 95% confidence intervals around the estimate of total cost, and around the estimated variable overhead per hour of repair time. Determine the predetermined overhead rate (POHR) at a budgeted activity level of 520 repair hours. How much of the POHR represents fixed cost applied per repair hour?

(2)

Given the following regression estimates:

Total cost = $6,472 + (12.52) x (RH) = $6,472 + (12.52) x (520) = $12,982 SEE (Y) = $ 678.00 SE (B1) = $ 1.58

(1)

Provide 95% confidence intervals around the estimate of total cost, and around the estimated variable overhead per hour of repair time. Determine the predetermined overhead rate (POHR) at a budgeted activity level of 520 repair hours. How much of the POHR represents fixed cost applied per repair hour? Assume that actual repair hours are 500, and actual total costs are $ 12,000, Determine the amount of over/under applied overhead for the period.

(2)

(3)

Given the following regression estimates:

Total cost = $6,472 + (12.52) x (RH) = $6,472 + (12.52) x (520) = $12,982 SEE (Y) = $ 678.00 SE (B1) = $ 1.58

(1)

Provide 95% confidence intervals around the estimate of total cost, and around the estimated variable overhead per hour of repair time. Determine the predetermined overhead rate (POHR) at a budgeted activity level of 520 repair hours. How much of the POHR represents fixed cost applied per repair hour? Assume that actual repair hours are 500, and actual total costs are $ 12,000, Determine the amount of over/under applied overhead for the period.

(2)

(3)

Multiple Regression
Is repair-hours the only activity that drives overhead costs at 3C?
Quarter
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

OH Costs
$9,891 $9,244 $13,200 $10,555 $9,054 $10,662 $12,883 $10,345 $11,217 $13,269 $10,830 $12,607 $10,871 $12,816 $8,464

Repair-Hours
248 248 480 284 200 380 568 344 448 544 340 412 384 404 212

Parts
$1,065 $1,452 $3,500 $1,568 $1,544 $1,222 $2,986 $1,841 $1,654 $2,100 $1,245 $2,700 $2,200 $3,110 $ 752

Multiple Regression Output

Compare the variable overhead per repair hour across both models. Why do they differ in this manner?

Multiple Regression Output Continued

Estimate 3Cs overhead for 520 repair-hours and $3,500 parts costs.

Total cost = $6,416 + (8.61) x (RH) + (.77) x (PC) = $6,416 + (8.61) x (520) + (.77) x (3,500) = 6,416 + 8.61 520 + .77 = $13,588 SEE (Y) = $ 517.00 SE (B1) = $ 1.71 =) = $ 0.24 SE (B2

+ V1 X1 + V2 X2

Total cost = = = SEE (Y) = SE (B1) = SE (B2) = (1)

$6,416 + (8.61) x (RH) + (.77) x (PC) $6,416 + (8.61) x (520) + (.77) x (3,500) $13,588 $ 517.00 $ 1.71 $ 0.24

Provide 95% confidence intervals around the estimate of total cost, and around the estimated variable overheads per hour of repair time and per dollar of parts cost. Determine the predetermined variable overhead rate (PVOHR) for repair time and parts cost. How would you determine the fixed overhead to be assigned to production? Assume that you are preparing a bid on a special customer order. You estimate that the project will require 100 repair hours and $ 200 in parts costs. Estimate the amount of variable overhead that you would assign to this project based on the results of the simple and the multiple regressions estimated above. Which of your estimates is more likely to be accurate?

(2)

(3)

Data Problems
Outliers Nonlinearity

Discretionary costs
Residuals assumptions Inflation

Outliers

Outliers
outlier

Regression line with outlier

regression line without outlier

Outlier changes the estimated regression line.

Nonlinearity

Dealing with non-linearity in estimating cost functions: A simple linear function: Y = a + b (X)

Linearity after transformation:

Piecewise linearity

Dealing with non-linearity in estimating cost functions: A simple linear function: Y = a + b (X) Linearity after transformation: Y = aXb

Piecewise linearity

Dealing with non-linearity in estimating cost functions: A simple linear function: Y = a + b (X) Linearity after transformation: Y = aXb ln(Y) = ln(a) + b(ln(X)) Piecewise linearity

Dealing with non-linearity in estimating cost functions:

A simple linear function: Y = a + b (X) Linearity after transformation: Y = aXb ln(Y) = ln(a) + b(ln(X)) Piecewise linearity (adding dummy variables to Allow for parameter shifts): Y = a + b(X) + c(D)(X)

Discretionary costs

Impact of discretionary costs such as advertising and maintenance spending: Assume that preventative maintenance is performed when the facilities have idle capacity. In addition, maintenance is deferred when the facilities are very intensely used. What would be the empirical relation between activity levels and maintenance costs?

Impact of discretionary costs such as advertising and maintenance spending: Assume that preventative maintenance is performed when the facilities have idle capacity. In addition, maintenance is deferred when the facilities are very intensely used. What would be the empirical relation between activity levels and maintenance costs? Assume that advertising is increased when sales levels are low. What would be the empirical relation between advertising and sales?

Residuals assumptions

Regression residuals: Discuss the importance to cost analysis of the following Assumptions concerning the residual or disturbance Term in the regression model: 1. Normality 2. Homoscedasticity 3. Independence

Regression residuals: Discuss the importance to cost analysis of the following Assumptions concerning the residual or disturbance Term in the regression model: 1. Normality 2. Homoscedasticity 3. Independence

Regression residuals: Discuss the importance to cost analysis of the following Assumptions concerning the residual or disturbance Term in the regression model: 1. Normality 2. Homoscedasticity 3. Independence

Inflation

 Inflation (deflation) is an increase (decrease) in the amount of currency required to buy a specific market basket of goods and services.

 Inflation (deflation) is an increase (decrease) in the amount of currency required to buy a specific market basket of goods and services. The relevant market basket is firm-specific.

 Inflation (deflation) is an increase (decrease) in the amount of currency required to buy a specific market basket of goods and services. The relevant market basket is firm-specific. Ignoring inflation will bias the parameter estimates in a manner similar to the impact of omitted variables.

 Inflation (deflation) is an increase (decrease) in the amount of currency required to buy a specific market basket of goods and services. The relevant market basket is firm-specific. Ignoring inflation will bias the parameter estimates in a manner similar to the impact of omitted variables. To avoid this bias, the currency measures should be adjusted from historical (nominal) dollars to inflation-adjusted (constant) dollars before computing the parameter estimates.

Example of inflation adjustments using the high-low method: Observation: Low High DLH 10,000 15,000 TOH (nominal $) $300,000 $400,000 Price index 1.50 1.80 TOH (constant $)

Estimating equation using nominal dollars: F=? V=? Estimating equation using constant dollars: F=? V=?

Example of inflation adjustments using the high-low method: Observation: Low High DLH 10,000 15,000 TOH (nominal $) $300,000 $400,000 Price index 1.50 1.80 TOH (constant $) $360,000 $400,000

Estimating equation using nominal dollars: F=? V=? Estimating equation using constant dollars: F=? V=?

Example of inflation adjustments using the high-low method: Observation: Low High DLH 10,000 15,000 TOH (nominal $) $300,000 $400,000 Price index 1.50 1.80 TOH (constant $) $360,000 $400,000

Estimating equation using nominal dollars: V = $20 F = $300,000 ($20)(10,000); F = $100,000 Estimating equation using constant dollars: V = $8 F = $360,000 ($8)(10,000); F = $280,000

Data Problems: Recapitulation

Outliers Nonlinearity

Discretionary costs
Residuals assumptions Inflation

Handout 2 (a): Using Linear Cost Functions

Handout 2(a) Linear cost functions: Consider each of the following independent cases: A. Total fixed costs are $80,000 and variable unit costs are $6.00. Determine the following amounts assuming that the firm produces and sells 10,000 units: (1) Total cost (2) Average cost (3) Unit fixed cost (4) Unit sales price required to earn a gross margin of $24,000

A. Total fixed costs are $80,000 and variable unit costs are $6.00. Determine the following amounts assuming that the firm produces and sells 10,000 units: (1) Total cost TC = $80,000 + 6 x 10,000; = $140,000 (2) Average cost AC = $140,000 / 10,000; = $14.00 (3) Unit fixed cost UFC = $80,000 / 10,000; = $8,00 (4) Unit sales price required to earn a gross margin of $24,000 S = AC + ($24,000 / 10,000); = $14.00 + $2.40; = $16.40

B. Average unit costs are $9.00 at an output of 5,000 units, and $8.00 at an output of 10,000 units. The total cost function is assumed to be linear. Determine the following: (1) Average unit costs at an output of 4,000 units (2) Average unit fixed costs at outputs of 4,000, 5,000 and 10,000 units (3) Sales prices per unit needed to earn a profit of $12,000 at outputs of 4,000, 5,000 and 10,000 units

B. Average unit costs are $9.00 at an output of 5,000 units, and $8.00 at an output of 10,000 units. The total cost function is assumed to be linear. Determine the following: (1) Average unit costs at an output of 4,000 units (2) Average unit fixed costs at outputs of 4,000, 5,000 and 10,000 units (3) Sales prices per unit needed to earn a profit of $12,000 at outputs of 4,000, 5,000 and 10,000 units Slope: ($80,000 45,000) / (10,000 5,000) = $7.00 Intercept: $45,000 ($7.00)x(5,000) = $10,000

Units 5,000 10,000

Unit cost Total cost $9.00 $45,000 $8.00 $80,000

Average unit costs: Output UFC UVC UTC 4.000 $2.50 $7.00 $9.50 5,000 $2.00 $7.00 $9.00 10,000 $1.00 $7.00 $8.00

UGM Price (UTC + UGM) $12,000 / 4,000 = $3.00 $12.50 $12,000 / 5,000 = $2.40 $11.40 $12,000 / 10,000 = $1.20 $ 9.20

C. Firm X has $60,000 of total fixed cost and variable costs of $4.00 per unit. Firm Y has $90,000 of total fixed cost and variable costs of $3.00 per unit. At what level of output do both firms have the same total cost?

C. Firm X has $60,000 of total fixed cost and variable costs of $4.00 per unit. Firm Y has $90,000 of total fixed cost and variable costs of $3.00 per unit. At what level of output do both firms have the same total cost? Set TC(X) = TC(Y) $60,000 + 4Q = $90,000 + 3Q Q = 30,000

D Firm Z has the following cost function: Total cost = $240,000 + (40%) x (Total revenue). Determine the following: (1) Total costs when revenues are $900,000. (2) Total gross margin when revenues are $900,000 (3) Total contribution margin when revenues are $900,000 (4) Contribution margin percentage (5) Gross margin percentage when revenues are $900,000

D. Firm Z has the following cost function: Total cost = $240,000 + (40%) x (Total revenue). Determine the following: (1) Total costs when revenues are $900,000. TC = $600,000 (2) Total gross margin when revenues are $900,000 TGM = $300,000 (3) Total contribution margin when revenues are $900,000 TCM = (60%) x (Total revenue); = $540,000 (4) Contribution margin percentage CM% = (100% - VC%); = 60% (5) Gross margin percentage when revenues are $900,000 GM% = TGM / TRev; = $300,000 / $900,000; = 33 1/3%

Handout 2 (b): Interpreting Regression Estimates

Handout 2(b):
Part A: Linear Constructs, Inc. is revamping its overhead costing, based upon statistical analyses of the relation of overhead costs to various activity levels that are possible drivers of overhead costs. As a start, the companys data analysts have estimated the linear relation of overhead costs (TOH) and direct labor hours (DLH) as follows:

TOH SEE (Y) SE (B1)

= Intercept + B1 x DLH + e = $9,000 + ($12.00) x (DLH) = $ 500.00 = $ 1.50

Assume that production activity budgeted at 500 direct labor hours. Based upon these parameter estimates and standard errors, address the following questions (for simplicity assume that 95% confidence intervals are measured as the estimated parameter plus and minus two standard errors). (1) Provide 95% confidence intervals around the estimate of total cost, and around the estimated variable overhead per direct labor hour. Estimate the predetermined overhead rate (POHR) at a budgeted activity level of 500 direct labor hours. How much of the POHR represents fixed cost applied per direct labor hour? Assume that actual repair hours are 600, and actual total costs are $ 15,000. Assume the company used the POHR estimated in (2) above, and determine the amount of over/under applied overhead for the period. Is the variance favorable or unfavorable?

(2)

(3)

(1)

Provide 95% confidence intervals around the estimate of total cost, and around the estimated variable overhead per direct labor hour.

(1)

Provide 95% confidence intervals around the estimate of total cost, and around the estimated variable overhead per direct labor hour.

TC = $9,000 + $12 x 500dlh; = $15,000 +/- (2)($500) B1 = $12 +/- (2)($1,50)

Shows the interval of the production.

(2) Estimate the predetermined overhead rate (POHR) at a budgeted activity level of 500 direct labor hours. How much of the POHR represents fixed cost applied per direct labor hour?

Predetermined overhead account take a look at.

(2) Estimate the predetermined overhead rate (POHR) at a budgeted activity level of 500 direct labor hours. How much of the POHR represents fixed cost applied per direct labor hour?
POHR = $15,000 / 500dlh; = $30 PFOHR = ($9,000 / 500dlh; = $18

(3) Assume that actual repair hours are 600, and actual total costs are $ 15,000. Assume the company used the POHR estimated in (2) above, and determine the amount of over/under applied overhead for the period. Is the variance favorable or unfavorable?

(3) Assume that actual repair hours are 600, and actual total costs are $ 15,000. Assume the company used the POHR estimated in (2) above, and determine the amount of over/under applied overhead for the period. Is the variance favorable or unfavorable?

Applied OH = $30 x 600dlh; = $18,000 Variance = $15,000 - $18,000; = $3,000 over-applied (favorable)

Part B: After evaluating the simple regression results described above, the firms
data analyst decided to incorporate machine time (MT) as an additional potential driver of overhead costs. The estimating equation was modified as follows:

TOH SEE (Y) SE (B1) SE (B2)

Required:

= = = = =

Intercept + B1 x DLH + B2 x MT + e $8,000 + ($9.00) x (DLH) + ($3.00) x (MT) $ 400.00 $ 2.50 $ 1.25

Assume that production activity is budgeted at 500 direct labor hours and 300 machine hours. Based on this expanded model and parameter estimates,

Multicolinarity.

Assume that production activity is budgeted at 500 direct labor hours and 300 machine hours. Based on this expanded model and parameter estimates, (1) Provide 95% confidence intervals around the estimate of total cost, and around the estimated variable overheads per direct labor hour and per hour of machine time.

Assume that production activity is budgeted at 500 direct labor hours and 300 machine hours. Based on this expanded model and parameter estimates, (1) Provide 95% confidence intervals around the estimate of total cost, and around the estimated variable overheads per direct labor hour and per hour of machine time.
TC = $8,000 + $9 x 500dlh + $3 x 300mt; = $13,400 +/- (2)($400) B1 = $9 +/- (2)($2.50) B2 = $3 +/- (2)($1.25)

Discuss why the estimated overhead per direct labor hour is lower, and the confidence interval for the overhead rate per labor hour is wider, when machine time is included as an additional driver in the cost estimation model.

Discuss why the estimated overhead per direct labor hour is lower, and the confidence interval for the overhead rate per labor hour is wider, when machine time is included as an additional driver in the cost estimation model.

Machine time is correlated with direct labor hours, and is an omitted variable in the earlier simple regression equation. Including machine time in the equation removes the coefficient bias, but the standard errors of the slope estimates are higher because of multicollinearity between the two independent variables.

(2) Determine the predetermined variable overhead rate (PVOHR) for labor hours and for machine time.
The predetermined variable overhead rates are simply the estimated slope coefficients for these two variables.

Assume that the intercept estimate in the above model is interpreted as budgeted fixed factory overhead. How would you determine the fixed overhead rate to be assigned to production? Would you develop a fixed overhead rate based on labor hours, machine time, or some other measure? Explain your reasoning.
There is no conceptually correct solution to this problem. In practical cases, the estimated intercept might be interpreted as fixed overhead, and arbitrarily divided by the budgeted level of one of the drivers (e.g., labor hours). In fact, the intercept is affected by omitted variables, non-linearity and measurement errors, and any allocation of this amount is arbitrary.

(3) Assume that you are preparing a bid on a special customer order. You estimate that the project will require 100 direct labor hours and 200 hours of machine time. Estimate the amount of variable overhead that you would assign to this project based on the results of the simple and the multiple regressions estimated above. Which of your estimates is more likely to be accurate?
Based on simple regression: VOH = ($12 x 100dlh); = $1,200 Based on multiple regression: VOH = ($9 x 100dlh) + ($3 x 200MT); = $1,500

Handout 2 (c): Inflation and cost estimation

Impact of inflation on estimation of cost functions:

Linear Structures, Inc. has gathered information on total maintenance costs and total direct labor hours incurred each quarter over the past five years (2007 through 2011). The company considers direct labor hours to be a suitable driver for its maintenance costs. The amounts of maintenance costs incurred in the lowest and highest activity quarters are provided in the table below:

Maintenance Costs and Direct Labor Hours, lowest and highest activity quarters Total maintenance Total direct costs labor hours Lowest quarter Qtr. 1, 2007 $ 4,000,000 500,000 DLH Highest quarter Qtr. 3, 2011 $ 4,500,000 550,000 DLH

Impact of inflation on estimation of cost functions:

Linear Structures, Inc. has gathered information on total maintenance costs and total direct labor hours incurred each quarter over the past five years (2007 through 2011). The company considers direct labor hours to be a suitable driver for its maintenance costs. The amounts of maintenance costs incurred in the lowest and highest activity quarters are provided in the table below:

Maintenance Costs and Direct Labor Hours, lowest and highest activity quarters Total maintenance Total direct costs labor hours Lowest quarter Qtr. 1, 2007 $ 4,000,000 500,000 DLH Highest quarter Qtr. 3, 2011 $ 4,500,000 550,000 DLH
Required: Assume that maintenance is a mixed cost and behaves in a straight-line fashion. Based on the
information in the above table, determine the intercept and the slope of the firms maintenance cost function, and discuss the plausibility of your estimates:

(a) Intercept (b) Slope

$_____________________ $______________per DLH

Required: Assume that maintenance is a mixed cost and behaves in a straight-line

fashion. Based on the information in the above table, determine the intercept and the slope of the firms maintenance cost function, and discuss the plausibility of your estimates: Reminder: Solve for the slope first, and then solve for the intercept.

(a) Slope $500,000 / 50,000DLH = $ 10.00 (b Intercept

$____10.00_____per DLH

$___-$1,000,000

$4,000,000 $10.00 x 500,000DLH = -$1,000,000

Linear Structures, Inc. has gathered information on total maintenance costs and total direct labor hours incurred each quarter over the past five years (2007 through 2011). The company considers direct labor hours to be a suitable driver for its maintenance costs. The amounts of maintenance costs incurred in the lowest and highest activity quarters are provided in the table below:

Maintenance Costs and Direct Labor Hours, lowest and highest activity quarters Total maintenance Total direct costs labor hours Lowest quarter Qtr. 1, 2007 $ 4,000,000 500,000 DLH Highest quarter Qtr. 3, 2011 $ 4,500,000 550,000 DLH
In addition to the information given above, you have just been informed that the types of maintenance costs incurred by the company have inflated by a cumulative amount of about ten percent over the past five years (i.e., prices at the end of 2011 are about ten percent higher than they were in early 2007). The price level is expected to be reasonably stable over the next few years. Based on this additional information, re-estimate the intercept and the slope of the firms maintenance cost function.

(a) Intercept (b) Slope

$_____________________ $______________per DLH

First, inflation-adjust the 2007 overhead costs: $4,000,000 x 110% = $4,400,000; then solve for the slope and the intercept:

(a) Slope $100,000 / 50,000DLH = $ 2.00 (b) Intercept

$____2.00_____per DLH

$___ $3,400,000

$4,400,000 $2.00 x 500,000DLH = $3,400,000

Linear Structures, Inc. has gathered information on total maintenance costs and total direct labor hours incurred each quarter over the past five years (2007 through 2011). The company considers direct labor hours to be a suitable driver for its maintenance costs. The amounts of maintenance costs incurred in the lowest and highest activity quarters are provided in the table below:

Maintenance Costs and Direct Labor Hours, lowest and highest activity quarters Total maintenance Total direct costs labor hours Lowest quarter Qtr. 1, 2007 $ 4,000,000 500,000 DLH Highest quarter Qtr. 3, 2011 $ 4,500,000 550,000 DLH

Assume instead that the maintenance costs have inflated by about 15 percent over the past five years, and re-estimate the intercept and slope of the firms maintenance cost function, and discuss the plausibility of your estimates.
(a) Intercept (b) Slope $_____________________ $______________per DLH

First, inflation-adjust the 2007 overhead costs: $4,000,000 x 115% = $4,600,000; then solve for the slope and the intercept:

(a) Slope

$____(2.00)_____per DLH

($100,000) / 50,000DLH = ($ 2.00) (b) Intercept $___$5,600,000

$4,600,000 (- $2.00) x 500,000DLH = $5,600,000

Handout 2(d)
Cost behavior and estimation: multiple choice questions

1. Utility costs at Service, Inc. are a mixture of fixed and variable components. Records indicate that utility costs are an average of $0.40 per hour at an activity level of 9,000 machine hours and $0.25 per hour at an activity level of 18,000 machine hours. Assuming that this activity is within the relevant range, what is the expected total utility cost if the company works 13,000 machine hours? A. $4,225 B. $3,250 C. $4,000 D. $5,200

1. Utility costs at Service, Inc. are a mixture of fixed and variable components. Records indicate that utility costs are an average of $0.40 per hour at an activity level of 9,000 machine hours and $0.25 per hour at an activity level of 18,000 machine hours. Assuming that this activity is within the relevant range, what is the expected total utility cost if the company works 13,000 machine hours? A. $4,225 B. $3,250 C. $4,000 The total costs are $4,500 at 18,000 hours and D. $5,200 $3,600 at 9,000 hours, so the variable cost per

MH is $0.10 ($900/9,000MH). The fixed cost is $2,700 ($3,600 (.10 x 9,000MH)). At 13,000 MH: $2,700 + .10 x 13,000MH = $4,000

2. Larson Brothers, Inc., used the high-low method to derive its cost formula for electrical power cost. According to the cost formula, the variable cost per unit of activity is $3 per machine-hour. Total electrical power cost at the high level of activity was $7,600 and at the low level of activity was $7,300. If the high level of activity was 1,200 machine hours, then the low level of activity was: A. 1,000 machine hours B. 900 machine hours C. 800 machine hours D. 1,100 machine hours

2. Larson Brothers, Inc., used the high-low method to derive its cost formula for electrical power cost. According to the cost formula, the variable cost per unit of activity is $3 per machine-hour. Total electrical power cost at the high level of activity was $7,600 and at the low level of activity was $7,300. If the high level of activity was 1,200 machine hours, then the low level of activity was: A. 1,000 machine hours B. 900 machine hours The cost varied by $300 and C. 800 machine hours D. 1,100 machine hours the slope is $3, implying that

the activity varied by 100MH. If the high level is 1,200MH, the low level is 1,100MH.

3. The following production and average cost data for a month's operations have been supplied by a company that produces a single product.

The total fixed manufacturing cost and variable manufacturing cost per unit are as follows: A. $3,600; $7.50 B. $7,600; $9.90 C. $7,600; $7.50 D. $3,600; $9.90

3. The following production and average cost data for a month's operations have been supplied by a company that produces a single product.

The total fixed manufacturing cost and variable manufacturing cost per unit are as follows: A. $3,600; $7.50 B. $7,600; $9.90 Total manufacturing overhead is $10,000 at C. $7,600; $7.50 D. $3,600; $9.90 1,000 units and $12,400 at 2,000 units, so the

variable overhead cost is $2.40 and the fixed overhead cost is $7,600 ($10,000 - $2.40 x 1,000). Unit variable cost is $9.90 ($7.50 + 2.40).

4. You are applying the scattergraph method and find that the regression line you have drawn passes through a data point with the following coordinates: 7,500 units and $10,000. The regression line passes through the Y axis at the $4,000 point. Which of the following is the cost formula that represents the slope of this line? A. Y=$4,000+$1.25X B. Y=$4,000+$0.80X C. Y=$10,000+$1.33X D. None of the above is true

4. You are applying the scattergraph method and find that the regression line you have drawn passes through a data point with the following coordinates: 7,500 units and $10,000. The regression line passes through the Y axis at the $4,000 point. Which of the following is the cost formula that represents the slope of this line? A. Y=$4,000+$1.25X B. Y=$4,000+$0.80X The intercept is given as C. Y=$10,000+$1.33X $4,000. The change in Y is D. None of the above is true

$6,000 ($10,000 4,000) and the change in X is 7,500 units, so the slope is $.80.