Four key assumptions examined in specification analysis are:1.Linearity between the dependent variable and the independent variable within the relevantrange.2.Constant variance of residuals for all values of the independent variable.3.Residuals are independent of each other.4.Residuals are normally distributed.
No. A cost driver is any factor whose change causes a change in the total cost of arelated cost object. A cause-and-effect relationship underlies selection of a cost driver. Some usersof regression analysis include numerous independent variables in a regression model in an attemptto maximize goodness of fit, irrespective of the economic plausibility of the independent variablesincluded. Some of the independent variables included may not be cost drivers.
No. Multicollinearity exists when two or more independent variables are highly correlatedwith each other.
Estimating a cost function
1.Slope coefficient=Difference in costsDifference in machine-hours
$3,900 – $3,0007,000 – 4,000
$0.30 per machine-hourConstant= Total cost – (Slope coefficient
Quantity of cost driver)= $3,900 – ($0.30
7,000) = $1,800= $3,000 – ($0.30
4,000) = $1,800The cost function based on the two observations is:Maintenance costs = $1,800 + $0.30 (machine-hours)2.The cost function in requirement 1 is an estimate of how costs behave within the relevantrange, not at cost levels outside the relevant range. If there are no months with zero machine-hoursrepresented in the maintenance account, data in that account cannot be used to estimate the fixedcosts at the zero machine-hours level. Rather, the constant component of the cost functionprovides the best available starting point for a straight line that approximates how a cost behaveswithin the relevant range.