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Chapter 2 addresses the following questions: Q1 What are different ways to describe cost behavior? Q2 What is a learning curve? Q3 What process is used to estimate future costs? Q4 How are the engineered estimate, account analysis, and two-point methods used to estimate cost functions? Q5 How does a scatter plot assist with categorizing a cost? Q6 How is regression analysis used to estimate a mixed cost function? Q7 What are the uses and limitations of future cost estimates? These learning questions (Q1 through Q7) are cross-referenced in the textbook to individual exercises and problems.
The textbook uses a coding system to identify the complexity of individual requirements in the exercises and problems. Questions Having a Single Correct Answer: No Symbol This question requires students to recall or apply knowledge as shown in the textbook. This question requires students to extend knowledge beyond the applications e shown in the textbook. Open-ended questions are coded according to the skills described in Steps for Better Thinking (Exhibit 1.10): Step 1 skills (Identifying) Step 2 skills (Exploring) Step 3 skills (Prioritizing) Step 4 skills (Envisioning)
2.1 This function has both fixed costs and variable costs. If at least part of the cost is variable; total cost increases as production volumes increase. If at least part of the cost is fixed, the average total per-unit cost decreases because the average fixed cost decreases as volume increases.
Q 2.2 Several years’ worth of data for August would be helpful for estimating the overhead cost function for subsequent Augusts, but the August data should not be used for estimating the overhead cost function for other months during the year. It is highly unlikely that the August data would be representative of the data during normal operations. However, August’s costs are probably a good estimate of the fixed costs for other months. When zero production occurs, only fixed costs are incurred. Since time appears to be of the essence, one of several cost estimation techniques might be employed. First, account analysis will provide a rough estimate. Second, the two most recent income statements could be used to approximate fixed and variable costs using the two-point method, but the president would need to understand that the quality of information could be low using this method. Third, if enough observations of cost data are readily available, regression analysis can be run. However, usually it takes more time to collect the data necessary to use regression analysis. The information leads to a conclusion that fixed costs exist because cost per unit changes between two levels of activity within the relevant range. The information is not sufficient to determine the amount of fixed costs or whether variable costs exist. The opportunities foregone could include spectator or participative sports activities, movies, going out to dinner, the opportunity to work at a part-time job, etc. The relevant cash flows include the cost of transportation, parking, tickets, food and beverages, and so on. There is no way to assign a quantitative value to the social experiences. It is difficult to identify a true opportunity cost because the costs and benefits of the next best alternative must be compared. However, lost wages, less the cost of transportation, can be quantified if the next if the next best alternative is working. Analysis of a scatter plot provided general information about whether a cost appears to be variable, fixed, or mixed. If there is a linear pattern in the scatter plot and the trend appears to go to zero, the cost could be variable. If a scatter plot with a linear trend intersects the vertical axis at a nonzero value, it could be mixed. If the scatter plot has no discernable pattern, the cost could be fixed. And if the pattern is linear with little or no slope, the cost could be fixed.
Chapter 2: The Cost Function
The pattern of a cost over time in the accounting system, together with knowledge of operations, is used to classify costs as variable, fixed, or mixed. Costs such as managers' salaries are usually fixed; they are often directly associated in the general ledger with a particular department or product. Costs for variable materials used in the production process are usually available in the general ledger or in production records. Costs such as manufacturing overhead are often mixed; they tend to include fixed costs such as insurance and property taxes for the plant and variable costs such as indirect supplies used in manufacturing. For costs identified as mixed, another cost estimation technique such as the two-point method or regression analysis must be used to determine the fixed and variable components. Learning curves are nonlinear representations of direct labor cost. The cumulative average time approach can be used to determine an approximation of total cost when labor experiences a learning rate. Economies of scale are a nonlinear function. Information about past experience with economies of scale can be used to help estimate future costs. For example, volume discounts are examples of economies of scale. The required volumes needed to reach discounted prices are generally known, so these can be estimated using several different ranges to reflect the changes in price. The cumulative average learning-time approach is a quantitative approach to calculating the average amount of time it should take to perform a task for people who are just learning to do the task. The director can use this formula to more accurately predict the amount of time it should take to deliver meals to the elderly. With a more accurate prediction, the volunteers’ schedules should also more accurately reflect the amount of time they need to set aside for their work at Meals on Wheels. The trend line developed using regression analysis incorporates all of the cost observations, while the two-point method uses only two observations. Because there is fluctuation in cost over time, better estimates are developed using more observations, because they better reflect the past fluctuations and therefore should better estimate future fluctuations.
2.11 Computer Manufacturer A. Production of a large monitor with a thin flat screen B. If all of the parts for the monitor are currently used in the organization, all of the information is likely to be contained in the accounting records. But new parts are most likely needed, since the monitor is large and probably involves different technology to achieve thin size. Thus, estimates of costs from suppliers will be needed. In addition, estimates for the amount of labor time will be needed. Although labor cost per hour can be found in the records, the amount of labor time is likely to be different for this monitor than for other monitors. If machines are used in production, an estimation of machine hours is necessary to determine whether maintenance and repair costs will increase. C. Estimating the cost of parts and the time involved in production is part of the engineered estimate of cost method. D. The opportunity cost of using idle capacity for one product is the contribution of other uses of the capacity. If another product could be manufactured and sold, that product’s contribution margin is the opportunity cost. If the capacity can be rented or leased out, the rent or lease payments are the opportunity cost. If there are no other uses for the capacity, the opportunity cost is zero. 2.12 Frida’s Tax Practice Cost Object Cost Subscription to personal tax law updates publication Ink supplies for tax department photocopy machine Portion of total rent for tax department office space Wages for tax department administrative assistant Tax partner's salary Charges for long distance call to Mr. Gruper about personal tax return questions Tax partner lunch with Mr. Gruper; the tax partner has lunch with each client at least once per year
Tax Department Personal Returns Mr. Gruper’s Personal Tax Return
A. B. C. D. E. F. G.
D D I D D D D
D I I I I D D
I I I I I D D
CPAs do keep detailed time records. 2. the CPA's time is the product being sold. and Piecewise Linear Cost Functions A.00*Q Graph of Cost Function $14. the tax partner probably spends some time in non-billable activities. the administrative assistant would have to maintain detailed time records as to time spent working on personal returns versus corporate returns.Chapter 2: The Cost Function 2-5 Explanation for Parts D and E: Notice that the wages of the tax department administrative assistant are considered a direct cost when the cost object is the entire tax department but are considered indirect for the other two cost objects.13 Linear.000 0 100 200 Number of Units 300 400 The cost function includes the following assumptions: • Operations are within a relevant range of activity • Within the relevant range of activity: o Fixed costs will remain fixed o Variable cost per unit will remain constant . TC = $10.000 $9.000 $10.000 $8. Of course. For the firm to make this cost direct for the personal returns cost object.000 Total Cost $12.000 $13.000 $11.000 + $8. so a portion of his or her salary is direct only to the tax department and indirect to the two other cost objects. The benefits of tracking the cost at that level do not exceed the benefits of the information that would be obtained. Stepwise Linear. Now notice that the tax partner's salary is considered a direct cost for all three cost objects. The time records that the tax partner maintains support this cost as a direct cost. In a service business such as this.
TC = $25.000)/(12.000 Graph of Cost Function $80.000 + $39*Q .000 . Convert the average costs to total costs for each production level: Total cost at 10.000 units: $450. it is first necessary to estimate the cost function. for Q > 2.$390.000 = $39 per unit Use one data point in the total cost function and solve for F: Using the data for 10.000 * $45 = $450.2-6 Cost Management B.000) = $78.000 $0 0 1.000 . To estimate the costs at another production level.00*Q.000 units = 12.000 F = $450.000 $10.000 3.000 – 10.000 2.000 $20.000 = F + $39*10.00*Q.000 + $8.000 $40.000 Calculate the variable cost per unit using the Two-Point method: Change in cost Change in volume = ($528.000 * $44 = $528.000 $30.$450.000 4.000 $60.000 = $60.000 $70. for Q ≤ 2.000 TC = $35.000 Total cost at 12.000/2.000 + $8.000 units = 10.000 Combining the fixed and variable costs to create the cost function: TC = $60.000 Number of Units C.000 Total Cost $50.
000 $45.000 + $10.500 2.500 2.000 = $43 D.000 + $39*15.00*Q 2-7 Graph of Cost Function $75.000 = $60.00) + $9.000 $50.000 + 45%*$10.000 in revenues into the cost function.000 = $645.000 units: TC = $60.000: TC = $50. total cost is estimated as: TC = $5.$9.000 $60.000 TC = $51.000 $55.000 * $10.00*(Q-1.000 Number of Units Slope is $10 per unit Slope is $9 per unit Total Cost .000 $65.00*Q .14 Piecewise Linear Cost Function A.000 $70. Inserting $10.000 + $585.000 + (1.000/15.000 + $9.000 For Q > 1.Chapter 2: The Cost Function Estimated total cost at 15. TC = $50.00*Q.000 1.000 Estimated cost per unit = $645. for Q < 1.000) TC = $50.000 + $10.000 = $9.000 + $9.000 0 500 1.
000 + $9.4. 2.000 units. then the cost function would appear to be: TC = $51. If the accountant did not detect that there were two different relevant ranges. then the cost function would be some mixture of the functions for the two relevant ranges.000 units but would underestimate total cost for Q ≤ 1.00*Q. Hours for two returns would be determined as follows. This cost function would provide reasonable estimates for Q > 1.3219 Y = 4. using the learning curve equation Y = α Xr Learning rate = 80% α = 6 hours X (units produced) = 2 Learning rate = (ln 0. There are three general situations: 1.15 Tax Plus A. Graph of Learning Curve Cumulative Average Hours Per Return 7 6 5 4 3 2 1 2 3 4 Cumulative Number of Returns Prepared .00*Q. If all of the data estimation points occurred when Q was > 1.000 + $10. This cost function would provide reasonable estimates for Q ≤ 1.2-8 Cost Management B.3 and 2A.80/ln2) = −0.000 units.8 hours (average time for each of the next two returns) B. then the cost function would appear to be: TC = $50.000 units but would overestimate total cost for Q > 1. 2.000 units. This cost function will either overestimate or underestimate costs for almost any level of Q (see Exhibit 2A.000 units.3219 Y = 6 hours*2-0. 3. the cost function mismeasurement depends on the values of Q. If all of the data estimation points occurred when Q was ≤ 1. If the data estimation points occurred across the two relevant ranges.
Total clay cost will vary with the number of bowls made. and variable costs remain constant within the relevant range.17 Glazed Over [Note about problem complexity: Items F and H are coded as “Extend” because judgment is needed for categorization. F Assuming that employee time can be traced to each bowl. B. 2. as their performance improves. I. The cost probably does not depend on production volume (assuming depreciation is not based on units produced). but would still be considered fixed because it does not vary with production volume. Depreciation on the kilns is indirect because it cannot be directly traced to individual bowls. this particular cost function assumes that variable costs are driven by sales.000 = 0. However. D or I. or 25% of sales Combining fixed and variable costs. if time is not traced to individual bowls (for example.Chapter 2: The Cost Function 2-9 As the accounting graduates become more familiar with the tasks involved in preparing simple tax returns. it is a common cost of production for all of the bowls that are heat-treated in the kiln. making it a fixed cost.000 on total sales of $32. it is a direct cost. V C. wages are a direct cost. Assuming that the cost of clay can be traced to each bowl. Eventually their learning will plateau. F .25. if the employee performs different types of tasks and records are not kept of the types of work performed) or if the employee does not work directly in production.16 Bison Sandwiches A. and their productivity rate will remain stable. it improves less quickly for the next return. 2. Assumptions: Fixed costs remain fixed within the relevant range.000/$32. However.000. that is. In addition. the cost function is: TC = $20.] A. Chapter 3 will point out another assumption for this cost function: the sales mix (the proportion of sales of different products) remains constant within the relevant range. Wages are fixed because they remain constant (the employee always works 40 hours). then variable cost per dollar of revenue is calculated as follows: $8. their productivity increases. D. Note: Depreciation using a method such as declining balance is not constant over time. If total variable costs were $8.000 + 25%*Total sales B. then wages would be an indirect cost.
300 Variable $4. J. They might be fixed or variable. F The business license is not related to production. 2. G. This cost is also discretionary. It is mostly likely a flat fee or is calculated on a basis unrelated to production volume. it is most likely traced to individual bowls. if the cost is small it might be grouped with overhead costs (variable). Advertising is not directly related to production. F I. if the cost is too small to justify tracing them). D or I. I. making it a direct and variable cost.500 ______ $4. E. this is a direct cost. Also. so it is treated as fixed.000 in sales $1. it is probably a mixed cost. If it is an hourly charge.18 Yummy Yogurt [Note about problem complexity: Item A is coded as “Extend” because judgment is needed for categorization.300 $3. I. V or F Brushes for the glaze are most likely used for multiple bowls.000 2. making them a common cost for multiple units and an indirect cost. D or I. F. It might be fixed or mixed. I.500 .2-10 Cost Management D. F or M Pottery studio maintenance is an indirect and fixed cost if it is the same payment every week. V Assuming that the cost of packing materials is traced to each bowl. I. F or M Electricity is an indirect cost because it cannot be traced to individual bowls. making it a fixed cost. Fixed Cost of ingredients Rent Store attendant (salaried) Total Costs at $9. If the kiln is electric. making it an indirect cost. If the packing materials are not traced (for example. Packing costs are most likely variable because they will increase as production increases. V If the glaze is expensive and therefore a relatively large cost. I. H. depending on what causes the cost to vary.] A. part of the cost might vary proportionately with volume. it might not be traced to individual bowls. because the production area may need more cleaning as volumes increase. making it an indirect cost. making it an indirect cost. then this cost could be indirect. If the cost of glaze is very small. depending on whether they are “used up” after a certain quantity of production.
the cost function is: TC = $3. In the pizza shop. FB. D. Benefit costs often vary with level of wages or salaries. Some may be sent home if business is very slow.50. In the fishing boat business. B. F. Therefore.Chapter 2: The Cost Function 2-11 B. workers’ compensation. Hourly wages on the fishing boat most likely vary with the number of days or hours the boat is out fishing. While hourly wages may be related to number of fish caught. F.500/$9. B.] A. The cost of rent is irrelevant because it will not change with either alternative. or M There would most likely be hourly wages in both types of businesses (assuming employees are hired). E. In this type of situation. or 50% of revenue Combining fixed and variable costs. costs vary with dollars of revenue. D. these costs would be mixed with a large proportion of the cost fixed. so they would tend to be fixed or mixed (see Item A above). 2. C. V Ingredients are used in making pizzas. this cost would most likely be fixed because the cost would not vary within a relevant range of activity. they are more likely related to time on the boat than pounds of fish. PS. and the cost would vary with number of pizzas produced. as well as voluntary items such as health insurance and retirement benefits. because of uncertainty in the success of each fishing expedition. B. Benefits might include mandated items such as social security.19 Pizza Shop and Fishing Boat [Note about problem complexity: Items C. F or M Employee benefits occur in any business in which employees are hired. F There would be no reason to incur fishing equipment costs in a pizza business. total revenue (TR) instead of quantity (Q) can be used in the cost function: Total variable cost/Total revenue = $4.000 = 0. V. employees are likely scheduled in advance on a fixed schedule. and unemployment insurance. and G are coded as “Extend” because they require substantial business knowledge and/or ability to visualize cost behavior. . In many organizations.300 + 50%*Total revenue C. There most likely would not be any ingredients in a fishing boat business. The opportunity cost is the contribution margin from the products sold with the flavor that has been replaced.
2414 2. however it would be unusual for a commercial fishing boat business to incur advertising costs because the customers are most likely canneries and distributors with whom the fishermen have an ongoing relationship.1075 0. It will be a fixed cost if it is a flat amount.15/45) 0.0179 4.59/16) 0. they are treated as fixed costs.95/2.0148 0.69/8) 0.1619 0.6815 .5196 Suggested selling price: 300% * $0. Cost of plain burger = $0.3489 $0. advertising costs would be incurred.59/40) 0.000) * 4] 0. Catsup ($. F Most pizza shops incur advertising costs such as flyers. The cost might be fixed or mixed. depending on how the insurance cost is calculated.0148 6.1619 10. In general.0233 7.0179 0. Cheese ($2. Mayonnaise [$1. the utility costs for these two businesses would tend to be fixed (would not vary with production). If the fishing boat is for tourists.1075 3. Cost of burger with everything except cheese = ($0.0233 0. B.0198 0. Hamburger patty ($1.0863 5. newspaper advertisements. Because advertising costs tend to be discretionary. Onions ($.1075 0. F. Dill pickles [($8. Tomato ($.6815 A.3489 (calculated above) B. PS.0033 0. and yellow pages advertisements.0053 0. there might be some utility costs for the fishing operation and for a business office.0198 9. For the fishing boat business.2414 $0.56 . 2.$0. but it might be mixed if a portion of the cost relates to levels of business activity.5195 = $1.1619) = $0. F or M Any type of business will have insurance costs.2414 $0. F Some type of utility costs (such as water and electricity) would be incurred in both types of business.69/7) $0.29/12) 0.0863 0.49/(16 x 4)] 0. Lettuce ($.20 Hamburger Haven Following are calculations for the cost per unit of each ingredient and the cost of plan and cheeseburgers: Cheeseburger Cost per Unit Plain With Everything 1.99/50) 0.0053 8. G.0033 $0. Mustard ($. although the cost would probably be much higher for the pizza business because of the utilities needed to run the pizza shop.2-12 Cost Management E. B.79/150) 0. Hamburger bun ($1.
$0. Alternatively. and then mixed C. It is just a general guideline." However.Fixed and discretionary I. Property taxes. Licenses. they set prices considering their competitors’ prices. B. she needs to know what competitors charge for a similar quality sandwich and price hers competitively. the price of the plain hamburger should be: $2.Chapter 2: The Cost Function 2-13 C. and F) are the ones requiring significant assumptions to generate an answer. FICA taxes (Social Security taxes) – Mixed – mostly fixed because most employee wages would be fixed J. Professional subscriptions. that cost would be variable.04 . there is no moral obligation to maintain a 300% markup on each item. 2. if her prices are too low. Clerical wages – Fixed unless overtime is regularly scheduled. Rent . B.Mostly fixed and discretionary H. volumes will drop because customers will go to other fast food restaurants that sell hamburgers.Fixed F.79 Some students will view this higher price as "unfair.Fixed D. most organizations are price takers.25 = $1. However staff are often salaried. Long is able to differentiate her hamburgers from others in the market. then she may be able to charge a price that is higher than competitors—as long as customers are willing to pay the higher price. This means that her costs need to be below the competitive price.04 Therefore. mostly variable G. Professional dues. D.Fixed E. Alternatively. Office supplies .6815 = $2. if Ms. Insurance. Selling price of cheeseburger with everything: 300% * $0. In the current business environment. If there is part time help.] A. Market forces will dictate achievable prices. in which case the total cost would be primarily fixed. she foregoes profits and people may believe there could be quality problems with her food.21 Spencer and Church [Note about problem complexity: These are difficult questions because students will need to first visualize the costs (with very little information) and then apply chapter concepts.Mixed. Staff wages – Could be variable or mixed (salary + overtime) for regular staff. that is. The Step 2 questions (A. Long’s prices are too high.Fixed . If Ms. Therefore.
The adjusted R-Square indicates how much of the variation in the marketing department cost can be explained by variation in units sold. the fixed cost is set at zero.22 Cost Function Using Regression. Therefore. Advertising – Fixed and discretionary 2.wiley. Other Potential Cost Drivers A. If this is the case. or profits.com/college/eldenburg). the analyst could ask the CFO whether the marketing department budgets its costs through a negotiation process with top management. A spreadsheet showing the solutions for this problem is available on the Instructor’s web site for the textbook (available at www.2-14 Cost Management K.com/college/eldenburg). the cost is discretionary and will be set through the negotiating process.wiley. For example. TC = $222. 2. In this problem. In addition. (Notice that the T-statistics on the fixed costs indicate that it is not likely to be different from zero.35*units sold. . Other possible cost drivers for marketing department costs could be revenue. number of advertisements placed.) B. it is possible that marketing costs are discretionary. available on both the Instructor and Student web sites for the textbook (available at www. The cost analyst needs to gather information about how marketing costs are set each year.23 Central Industries [Note about problem complexity: Item B is not coded as Step 1 because it is fairly clear which cost driver appears to be best. the variation in units sold explains about 61% of the variation in marketing department cost.] The data for this problem can be found on the datasets file for chapter 2. C.
026826 0.113687834 Intercept Output t Stat 5.761602 4.500 Maintenance Costs $2.61765897 0.000 $500 $0 0 500 1000 Output 1500 2000 Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations 0.58E-05 0.52099624 Standard Error 153.000514 .Chapter 2: The Cost Function 2-15 A.582691 P-value 6. Potential Cost Driver: Output Maintenance Costs Against Output $2.4342166 0.58824812 182.000 $1.119724 15 Coefficient s 884.78591283 0.500 $1.
000 $500 $0 0 50 100 150 200 250 300 350 Direct Labor Hours Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations 0.02569657 Standard Error 261.2-16 Cost Management Potential Cost Driver: Direct Labor Hours Maintenance Costs Against Direct Labor Hours $2.500 $1.31319046 235.457384 3.005847 0.7549386 1.36224828 0.717372 P-value 0.000 $1.500 Maintenance Costs $2.60187065 0.291084 2.017601 .113464425 Intercept Direct Labor Hours t Stat 3.210849 15 Coefficient s 861.
This indicates that the cost could be totally variable. However. a good cost driver would present a linear or football-shaped positive slope or trend.96E-10 B. If the observations are widely scattered. the cost driver does not explain the variation in cost and either it is the wrong driver.5343 P-value 0.97410583 0.910475729 Intercept Machine Setups t Stat 1. Sometimes a cost that is mostly variable can be identified from a scatter plot. . or the cost is mostly fixed. all three potential cost drivers appear to be positively related to maintenance costs.357393 15.94495003 66.000 $1.815737 29.42597461 1. machine setups appears to be the most likely cost driver and direct labor appears to be the least likely cost driver. the trend line for machine setups looks as if the intercept could be zero or very close to zero. In Part A. For example. In a scatter plot.94888217 0.500 $1.000 $500 $0 0 20 40 Machine Set-Ups 60 80 Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations Coefficient s 126.Chapter 2: The Cost Function 2-17 Potential Cost Driver: Machine Setups Maintenance Costs Against Machine Set-Ups $2.500 Maintenance Costs $2.6778973 0.5913391 15 Standard Error 93.197755 8.
business processes.945 Cost Function TC = $884 + $0. so it is excluded from the cost function. E. This provides confidence that the variable cost part of the cost function is not zero. Therefore. The use of past cost data to predict the future assumes that future resource costs and volumes of activities will remain the same as in the past. the economic environment. the t-statistic is significant for the independent variable but not for the intercept. but does not provide confidence that the intercept (fixed cost) part of the cost function is different from zero. In the machine setups regression. R-Square 0.521*Output TC = $861 +$3. .945. The regression using machine setups has the highest adjusted R-Square of 0.313 0. and technology can cause future costs to be different than estimated.025*Direct Labor Hours TC = $29. This means that variation in setups explains about 95% of the variation in cost. the cost is likely to be totally variable. Changes in many factors such as resource prices. D.68* Machine Setups The machine setups intercept coefficient is not significant.588 0.2-18 Cost Management C. The regression results and cost function for the three potential cost drivers are: Potential Cost Driver Output Direct labor hours Machine setups Adj.
132. First. the cost function is calculated using the highest and lowest values of the cost driver.605 = $11. That means that the cost function might not represent the actual cost. Under the high-low method. Total revenue (TR) instead of quantity (Q) in the cost function because sales is a potential cost driver. that is.333 = F + 5%*$1. the total cost function is: TC = $11.24 Big Jack Burgers A.132.100 F = $68.333 – $43. on average. Therefore.333)/($1. not represent the cost most of the time.728 + 5%*Sales B.100) = $25.000/$500.000 = 0.$56.100 – $632.728 Thus. . which could be outliers.Chapter 2: The Cost Function 2-19 PROBLEMS 2. or 5% of sales The fixed cost is determined by substituting the variable cost into one of the high-low data points: $68. the variable cost is calculated: ($68. this cost function might provide poor estimates of future costs. The high low method uses the most extreme cost driver values.05.333 .
D. Following is the regression output. If this cost pool includes items such as salaries and other fixed costs (insurance. The upward slope of the line indicates that there are variable costs. there is a 16% probability that the intercept (fixed cost) is not different from zero. the p-value result for the tstatistic is atypical. the cost function would be: TC = 4. Analysis at the account level can be used to increase the understanding of this cost. Then. Because this regression has few observations. Based on the p-value. but the p-value is greater than 10% at 0. Chart of data with trend line added by Excel.800 + 4.000 $900.2-20 Cost Management C.000 Administrative Costs $60. trend line extended to Y-axis (dashed line) using Word: Scatter Plot With Trend Line $80.000 $1. fixed costs are likely to be zero and would be excluded from the cost function. In that case.200.000 $0 $0 $300.162. There is a general downward slope (variable cost) that appears to meet the intercept enough above zero to suggest a fixed cost.5% x sales. the regression intercept can be used as an estimate of the fixed costs. A t-statistic greater than 2 is often interpreted as meaning that the coefficient is significantly different from zero. Alternatively.172. the cost function would be TC = $16. analysis at the account level might indicate that there are few fixed costs. Additional judgment is required to decide whether it is appropriate to include a fixed cost in the cost function.5% x sales . Notice that the t-statistic for the intercept coefficient is 2.000 $600.000 Sales It appears that the cost is most likely mixed.000 $40. etc). Then.000 $20.
365 + 0. however. Future costs are not likely to be estimated accurately if the cost driver explains only a small part of the variation in the cost. on average. Unusual cost items are assumed to continue in the future. This means that variation in sales explains only about 18% of the variation in research and development cost.Chapter 2: The Cost Function 2-21 Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations 0.4038 4 Coefficients Standard Error 16800. and it can be further improved by adopting more representative data points than the highest and lowest values of the cost driver. This method can be used in cases where there is not enough data to perform regression. Cost Function Using Regression A. Therefore. regression analysis incorporates all of the observations into the analysis. causing fluctuations in cost that are unrelated to any cost driver.82%*Sales C. there does appear to be a general upward trend.25 Scatter Plot. If there are only two or three data points.2444 7734.45937486 P-value 0.00818212 t Stat 2. Sales might not be the activity that drives administrative costs. Because of unforeseen changes in cost behavior. The plot shows costs that are widely scattered. B. If there are more data points.186. If these assumptions do not hold. The cons of the high-low method as an estimation technique were discussed in Part B above.93711636 0. There might be a large discretionary component in administrative costs. a cost function may not provide a good estimate for the next month’s costs.9680477 0. the high-low method may be the best option available. The adjusted R-Square statistic is very low at 0. then both methods may be unsuitable for estimating future costs. Both methods assume that the cost function is linear and that all data points come from a single relevant range. the results rely on more complete information and provide a better estimate.0319523 Intercept X Variable 1 E.17205158 5. However. and possible changes in costs such as those described in Part E are ignored. . The past costs used for estimation might not be representative.04466925 0. Sales does not appear to explain much of the variation in research and development costs. F. both of these methods assume that the data points are representative of future costs. the cost function is: TC = $50.16197623 0.73545 0.90567454 3293. There might be a change in business operations or in the economy that would cause future costs to be different than in the past. especially because so few observations were used in the estimation. 2. Using the regression results. In addition.
Several very general assumptions apply to a linear cost function. usually annually. the cost of alternatives such as cellular service or any other types of telephone or communication service. B. 2. the relation makes sense from an economic standpoint. to make a decision she needs to compare her costs under the old plan to what costs would be under the new plan. so she does not need to estimate the cost function using regression or any other estimation technique. The variable cost is 10 cents per minute for those minutes over 500 per month. It is likely that Susan has to call people to conduct business. The cost driver for long distance calls is the number of minutes on the telephone. a portion of the cost is likely to be discretionary. E. D. When regression analysis is used to specify a cost function. The classification as direct or indirect depends on whether Susan’s calls are directly related to specific projects she works on or are indirect activities such as business promotion. the amount of traveling she will be doing since she cannot call from home when she is traveling. that is. She cannot be certain that she will use the same amount of time. Therefore. The fixed cost is the $20 flat fee. Better cost estimates for discretionary costs can be obtained by gathering information about planned expenditures from the department head or from the managers who are responsible for costs. fixed costs would remain fixed and variable costs would remain constant within that range. the number of calls and whether they are long distance or local calls will vary. Since she probably can cut back on calls when her consulting work is not providing enough income. although she could use email. Since she has to have telephone service to stay in business. Yes. part of the cost is committed and cannot be reduced. F. C.26 Susan’s Telephone Service A. Managers set the costs depending on the organization’s strategies and funds available for research and development. on average. Additional information could include the location of Susan’s future consulting work. the cost is assumed to be linear within the relevant range. Susan already knows the cost function. In this problem. In addition. The scatter plot shows little evidence of linearity.2-22 Cost Management D. research and development cost is often discretionary. assuming that the cost function is linear may not be appropriate. First. G. These costs are set by decision. In this problem. It also depends on whether she can trace telephone calls to individual . the underlying cost function is assumed to be linear and that the cost driver is assumed to be economically plausible as a cost driver. Since her consulting work varies. as she has in the past. H. Regression is useful for estimating a cost function when fixed and variable costs are unknown.
057 The average cost is lowest at exactly 500 minutes per month. In most businesses.05 $0.00 $20.04 $0.Chapter 2: The Cost Function 2-23 consulting jobs. Many cellular telephone bills do not list the calls made. If her calls are over 400 minutes or under 600 minutes. There are many different reasons that the time could be different from the amount determined above. It is possible that the managers under. so Susan may need to maintain her own records if she wishes to trace telephone usage.00 $20. her phone bill will be less than it would be at a rate 5 cents per minute. she may be paying for 500 minutes of service that she does not use • If Susan’s calling volume exceeds 500 minutes per month.00 + (600-500)*$0.00 $20.00 Average Cost $0.05 $0. In this case the learning rate would be wrong and so the time would also be wrong. using the learning curve equation Y = α Xr α = 10 hours X (units produced) = 4 Learning rate = (ln 0.10 = $40. students may think of others. which appears to be the other alternative (although the 5 cents per minute rate might not be available for daytime week day calls). Hours per batch would be determined as follows.067 $0.90/ln2) = −0. Pros: • Susan might prefer the convenience of not switching telephone companies • If Susan is happy with her current quality of service she might prefer to stay with the same company and not investigate other companies’ plans • Susan may be able to predict her cost better. Cons • If Susan has a number of projects in her local area or will be traveling a lot. Here are some of the reasons.or overestimated the amount of hand work performed. telephone costs are viewed as an indirect cost. Minutes 300 400 500 600 700 Total Cost $20. I. especially if she usually calls less than 500 minutes a month • Below is Susan’s average cost per minute at different levels of calls per month. she will pay a very high rate of 10 cents per minute 2.1 hours (average time for the first four batches) B.152 Y = 10 hours*4-0.00 + (700-500)*$0.27 Fancy Furniture A. In .10 = $30.00 $20.152 Y = 8.
000 Total revenue is the most likely cost driver for both variable costs. the cost function is: TC = $47. C. 2.40. The estimate of total costs given revenues of $80.000/$70. The observations of labor costs over the first few weeks would not be representative of the labor costs once productivity has stabilized. the rate will change if the replacement employee has never worked on this machine.000 Variable $21. then the chart suggests that the learning rate estimate is reasonable.2-24 Cost Management addition. and B. However.000 1. Because revenue is the cost driver for both variable costs.000 = 0. if managers believe that 25% of the work is done by hand. D.$79. if managers believe that more than 25% of the work is done by hand. If these values are used in a regression to estimate a cost function. it is possible that different types of wood affect the rate at which chairs can be produced.000 5. or has a great deal of experience on the machine. Food costs are likely to vary proportionately with sales.000 7.000 _______ $28. and the University surcharge is specifically based on sales.000 . C. The chart suggests that a 90% learning curve is likely to occur if 25% of the work is hand assembly and 75% of the work is done by machine.000 + 40%*Total revenue D. or 40% or revenue Combining fixed and variable costs. Thus.000 = $1.000 . If a worker is absent one day.000 + 40%*80.28 Wildcat Lair A. they would be higher than the labor costs in later periods. then this chart suggests that the learning curve will be slower than the 90% estimate.500 10. Wildcat Lair costs: Purchases of prepared food Serving personnel Cashier Administration University surcharge Utilities Totals Fixed $ 30.000 = $79.000 using the cost function is: TC = $47.000 Profit = Revenues – Total costs = $80. total revenue (TR) instead of quantity (Q) can be used in the cost function: Variable cost = $28.500 $47. then the cost would be overestimated.
000) Net 2. So.000 increase in revenues is expected to be $6. but this is not considered a cost driver (a business activity that causes variations in total variable cost). generating most its sales around the ski season (fall and winter). A shop located near a ski area is likely to incur high heating costs during the winter.) The adjusted cost function is: TC = $47. (This is the same as the previous 40% variable cost rate less the university surcharge of 10% of revenues. if the bathing suit shop is located in a geographic region $80. To estimate the opportunity cost for August. this surcharge should be ignored when computing the university’s opportunity cost (assuming that the charge does not relate to any variable costs for the university that arise because of the Lair). Because the university surcharge is an allocation within the university. If the university were to close the Lair.000.000+$6.000). it might even close when the ski area shuts down. However.29 Polar Bear Ski Wear [Notes about problem complexity: Item A is not coded as Step 2 because this is explicitly discussed in the chapter. electricity usually varies with hours of operation and possibly with the season (because of heating and air conditioning).] A. costs would be higher when there were fewer sales.000 . so the trend would be the opposite of this plot.000) of revenues. Electricity costs also vary with changes in electricity rates.000 (47. Item D will be VERY difficult for most students.000) $ 9.000 . Lair’s fixed costs are assumed to be unchanged with the $10. So. for July the opportunity cost would have been $2.000. Assuming the highest electricity cost is during the winter when fewest bathing suits are sold. total variable costs are expected to increase by $4.000*40%). Only total variable costs are expected to increase. less the fixed costs and the variable food costs. the shop might experience very little business activity. Variable food costs are estimated to be 30% ($21.000 ($10.000)+the university surcharge of $7.000) (24. the additional profit from a $10.$4. F. so the estimated profit in August is $1.Chapter 2: The Cost Function 2-25 E. During the spring and summer months. it would lose the revenues.000 increase in revenues. In July there was a loss of $5.000). B.000 ($10.000 + 30%*Total revenue During August.000 (-$5.000— the operating loss of $(5.000/$70. C. In a retail business. Thus. the opportunity cost is estimated to be: Revenue Fixed costs Variable costs (30%*$80. the variable cost part of the cost function can be adjusted. and the increase is estimated to be 40% of the increase in revenues. The shop is most likely a seasonal business.
A correlation may appear in a scatter plot or regression analysis. firm B's selling price is: $101. special promotions.2345 Y = $101.69 x 5 = $1.69 (average cost for each of the 5 units) Total cost = $205.30 Firm A and Firm B Costs for Firm A in the first year would be determined as follows.45 $ 514. 2.2345 Y = $300*5-0.542.028. employee training.50 = $1.2345 Y = $205.5 = $152.89 x 1.028.028.89 (average cost for each of the 100 units produced) Given a 50% markup on cost. correlation does not necessarily mean causation. However. generally mean there is more money available to spend on administrative travel. a 50% markup on total cost will cause sales to be: $1.84 . given a 100 unit production level: Y = α Xr Y = $300*100-0. D.67 1.45 x 1. Although these expenditures are made because more money is available. then the highest sales might coincide with the highest electricity costs. and new office furniture or equipment.2-26 Cost Management where the highest electricity costs occur during the summer because of air conditioning. For example.85/ln2) = 0. Many costs can be related to volume of activity.22 Firm B set its selling price based on the average cost. using the learning curve equation Y = α Xr α = $300 instead of hours X (units produced) = 5 Learning rate = (ln 0. they are discretionary expenditures and not caused by the level of activity. higher profits generally occur during periods when activity is high.45 Although each customer paid a different price.67 Firm A's income for last year was: Sales Costs Income $1. in turn. Higher profits.542.
50/150 units = $64.727. assuming an 85% learning effect would be: Y = $300*150-0.85 x 1.00 13.028.10 $ 172.384.727.356.10 $22.528.30 $2.75 (average cost for each of the 300 units) Note that the cumulative production for Firm B through this year is 300 units.Chapter 2: The Cost Function 2-27 Firm B's costs.00 13.50 = $97.40 Firm A's costs may be computed as follows: Y = $300*15-0.897.97 (average cost for each of the 15 units produced) Total cost to produce the first 15 units (15 x $158.40 1.84) Costs (150 x $ 92.50 $ 9.2345 Y= $78.84) = $1.65) Income Firm A's revenues for this year are: (10 x $152.65 (average cost for each of the 150 units produced) Firm B's income statement for last year was: Sales (150 x $152.2345 (notice that the cumulative units produced is 15) Y = $158.926.55 1.2345 Y = $92. Total cumulative production cost (300 x $78.97) Less costs from last year’s income statement for first five units Cost to produce the 10 units for this year Thus Firm A's income statement for this year is Sales Costs Income $1.028.85 Thus Firm B's selling price this year was $64.356.50 $ 9.45 $1.625.528.50 .28 $23.50 Firm B's calculation for its selling price is as follows: Y = $300*300-0.897.75) Total costs to produce the first 150 (from last year’s income statement) Total costs of this year’s production (150 units) Average cost per unit = $9.
Scatter Plot of Marketing Costs Against Sales $175.000 Sales B.500.000 $6. Such results often lead to charges of "unfair dumping" but with large differences in cumulative production volumes.500. A. .2-28 Cost Management Firm B's income statement for this year is Sales (150 x $97. There is a positive slope.500. 2.10/10 = $135.000 $135.592.61.wiley.000 $155.28 is lower than Firm A's average cost per unit: $1. Costs $165.com/college/eldenburg). A spreadsheet showing the solutions for this problem is available on the Instructor’s web site for the textbook (available at www.000 $145. and most of the observations appear to have a fairly linear trend. available on both the Instructor and Student web sites for the textbook (available at www.00 9.85) Income $14.wiley.50 Note that Firm B's selling price for this year of $97.000 $7.864.500.356.50 $ 4. Sales seems to be a potential cost driver because there appears to be a positive correlation between the marketing department costs and sales.727.28) Costs (150 x $64.31 Belford’s The data for this problem can be found on the datasets file for chapter 2. such extreme differences in cost can occur.000 $8.com/college/eldenburg).000 Marketing Dept.000 $5.
the decision maker(s) should be asked what next year’s cost will be. Instead. the cost estimate should not be based on past costs. the cost function is: TC = $65. sales may go up. Regression Statistics Multiple R 0.4501E-10 5. Assuming that profits are more likely to increase when sales increase. Here is the regression output. there would be a positive correlation between marketing department costs and sales.584 + 1. using regression or any other technique. When more money is spent on marketing. Therefore.86656716 Standard Error 4015.5289E-14 Intercept X Variable 1 Based on the regression results.58184484 13.2608 0. they may be positively correlated with sales. In addition. E. Discretionary costs are set by decision. Even if marketing department costs are discretionary. discretionary costs such as marketing are often increased when profits increase.87116829 Adjusted R Square 0.08144 Observations 30 Coefficients 65584.63816 0.93336396 R Square 0. If the variable portion of the marketing cost is sales commissions. usually annually.00097028 t Stat 9. it is economically plausible for sales to be a cost driver.34%*Sales D.7600071 P-value 2. F.01335108 Standard Error 6844. .Chapter 2: The Cost Function 2-29 C.
2-30 Cost Management 2.000 $0 0 300 600 900 1200 1500 Machine Hours .000 $160.com/college/eldenburg).000 $120. Manufacturing Overhead Against Labor Hours Manufacturing Overhead Cost $200.wiley.000 $40.000 $120. A.000 $0 0 500 1000 1500 2000 2500 Labor Hours Manufacturing Overhead Against Machine Hours Manufacturing Overhead Cost $200.000 $80.com/college/eldenburg).000 $80. A spreadsheet showing the solutions for this problem is available on the Instructor’s web site for the textbook (available at www.32 Peer Jets International The data for this problem can be found on the datasets file for chapter 2.000 $40.wiley.000 $160. available on both the Instructor and Student web sites for the textbook (available at www.
86E-11 0. the cost driver does not explain the variation in cost.50852 7.000 $80. either the driver is wrong or the cost is mostly fixed. Sometimes a cost that is mostly variable.552864 . Labor Hours Regression: Regression Statistics Multiple R 0.1543 0.600936029 Intercept Labor Hours t Stat 10. Based only on the cost plots. labor hours could be deleted as a potential cost driver. C.8173 Observations Coefficient s 150410.000 $0 0 100 200 300 400 500 600 700 Raw Materials B.000 $160.02253618 Standard Error 11114. Analysis of the plots involves looking for a linear or football-shaped positive slope or trend.11279932 R Square 0.000 $120.Chapter 2: The Cost Function 2-31 Manufacturing Overhead Against Raw Materials Manufacturing Overhead Cost $200. If the observations are widely scattered.56597156 30 Standard Error 14812. Costs and potential cost driver data are plotted to determine whether further analysis is necessary.682 4.000 $40. D. None of the plots show a definite trend.01272369 Adjusted R Square -0. The plots help determine whether regression analysis should be performed using any of the potential drivers. but the plot for labor hours appears to have the least trend.600712 P-value 6.
095468 P-value 4.599 + $38.082222 P-value 3.2533351 Adjusted R Square 0.47803 9.217 + $60.67 38.004579 Both the intercept and slope coefficients are significant. so the cost function is estimated as: TC = $150.331580777 Intercept Machine Hours t Stat 11.53627459 Intercept Raw Materials t Stat 11.68E-12 0.22* Raw materials . so the cost function is estimated as: TC = $117.11E-12 0.56778 19.91 60.5033241 R Square 0.215128 Standard Error 10853.2266685 Standard Error 9665.62907 3.1555 Observations 30 Coefficient s 117598.217192 Standard Error 10291.411 Machine Hours Regression: Regression Statistics Multiple R 0.22*Machine hours Raw Materials Regression: Regression Statistics Multiple R 0.3522862 Standard Error 8846. so the cost function is estimated as: TC = $126.2-32 Cost Management Only the intercept term is significantly different from zero.000325 Both the intercept and slope coefficients are significant.612063 R Square 0.9786 Observations 30 Coefficient s 126216.4268 4.3746211 Adjusted R Square 0.
210187 P-value 3. 2.12E-09 1.3E-06 0.1959303 48.953575 1.wiley. however. A.33 Peer Jets International (continued) The data for this problem can be found on the datasets file for chapter 2.976635 Standard Error 10361. Multiple regression with all three potential cost drivers: Regression Statistics Multiple R 0.08E-08 .2349 3.352 0.Chapter 2: The Cost Function 2-33 E.com/college/eldenburg).8067018 Standard Error 4832. A spreadsheet showing the solutions for this problem is available on the Instructor’s web site for the textbook (available at www. Labor hours can be eliminated as a potential driver because its coefficient is not significantly different from zero (see Part D).778501 82. and the adjusted R-Squares from the regressions are: Machine Hours Raw Materials 0.wiley.886218 -0. the direct labor hours was not significantly related to manufacturing overhead costs using simple regression. The coefficients for each of the other potential cost drivers are significantly different from zero.05878 9.9092294 R Square 0.5558 Observations 30 Coefficient s 60988.226 Based on the simple regression results. this driver explains only 35% of the variation in cost.com/college/eldenburg). F.489 -0. machine hours appears to do the best job of explaining manufacturing overhead costs.218173 8.291558412 10. Yes.10654585 Intercept Labor Hours Machine Hours Raw Materials t Stat 5.8266982 Adjusted R Square 0.333162437 5. available on both the Instructor and Student web sites for the textbook (available at www.
411 (<0.939606 9.954) $48. Manufacturing can be a complex activity requiring a number of different tasks.226) for these two cost drivers.90921678 R Square 0.93*Raw materials D.001) $4.022 0.988 (<0.57 (0.664851 5. A combination of cost drivers does a much better job of explaining the variation in manufacturing overhead costs than either cost driver alone.881964042 Intercept Machine Hours Raw Materials t Stat 6.352 and 0.599 (<0. Multiple regression using machine hours and raw materials as cost drivers: Regression Statistics Multiple R 0.74*Machine hours + $82. C.001) $117. Also.001) $60.925842 30 Standard Error 8743.352 0.001) $-0. R2 Simple Regressions: Labor Hours Machine Hours Raw Materials Multiple Regression 0. Labor hours does not appear to be a cost driver when using either simple regression or multiple regression.157604083 9.001) B.22 (0. Each task includes different activities.450561 8.226 0.81383627 Standard Error 4742.98 (<0. Both machine hours and raw materials are positive and significantly different from zero when using simple regression and also when using multiple regression. machine hours and raw materials explain different activity .2-34 Cost Management Comparison of simple and multiple regression results: Intercept t-stat (p-value) Independent Variables t-stat (p-value) Labor Machine Raw Hours Hours Materials Adj.001) $60.391636 P-value 1. labor hours can be eliminated as a potential cost driver.71E-10 5. its coefficient is not significantly different from zero in either regression.55) $38.5902 48.5348 Observations Coefficient s 60677.806) than in either of the simple regressions (0. Thus.29E-09 The cost function is: TC = $60. Costs for these activities are likely related to specific cost drivers.678 + $48. In this example.7422519 82. The adjusted RSquare is far higher in the multiple regression (0.001) $126.20 (0.86E-07 4. its coefficient is negative rather than positive in the multiple regression.82667515 Adjusted R Square 0.78 (<0.22 (<0.806 $150.217 (<0.005) $82.
the department amounts and total budget may be quite inaccurate. the board may begin to lose trust in the CEO’s ability to manage operations. Regina should submit the most current information she has. She can tell the Director of Finance that she cannot produce a very accurate budget within two days or she can pull together something that may not be very accurate. The board of directors monitors the performance of the CEO and top management. they need the most current information available and explanations for information that is not available. If Regina submits unrealistically low budgets this month and then more accurate budgets next month. They may either praise or criticize top management when the situation may not warrant it. More importantly. She may believe that her reputation as a diligent employee would suffer if she cannot produce something. They may also use the inaccurate information to help them approve decisions. such as a business expansion. her reputation would also suffer. Although the board is not directly involved in day-to-day operations. in their role of oversight. B. .34 Software Solutions A. This is a potential ethical dilemma for Regina because the Direct of Finance believes that he can rely on Regina’s work when he presents the budget to the board. If Regina uses last period’s budget. and use last year’s budgets for departments that have not turned theirs in. When the budget is complete the board will likely see it again and notice the discrepancies between the preliminary and actual budgets and wonder why the first budget was so inaccurate. and materials handling for the units. Regina has at least two choices in this situation. However. The relationship between the CEO and the board should be one of trust and confidence. C. with a flag indicating that the information quality is low for the budgets in those departments and an explanation that the budget is currently based on last year’s information. and the Director of Finance will present the board with information that is unreliable. If they have outdated information and inaccurate information. if she submits a budget based on last year’s budget and she knows that this is likely to be inaccurate. A better understanding of the manufacturing process improves the ability to determine the types and number of cost drivers that can be used in a more complete cost function. they will draw erroneous conclusions about the performance of the organization and the top management. but with large increases in department costs. the board may make inappropriate decisions based on faulty data. 2. and that could reflect negatively on the Finance Director.Chapter 2: The Cost Function 2-35 costs. such as machining work on units.
2-36 Cost Management 2. A.000 $15.000 $0 50 100 150 200 250 300 350 Maintenance Hours Worked Scatter Plot of Maintenance Costs Against Number of Students Maint.000 $20.com/college/eldenburg). .000 $15.000 $0 528 530 532 534 536 538 540 542 Number of Students C. A spreadsheet showing the solutions for this problem is available on the Instructor’s web site for the textbook (available at www. B. available on both the Instructor and Student web sites for the textbook (available at www. Dept.wiley.000 $10. or number of classes and activities per period. number of hours the building is open. square feet cleaned.wiley.000 $5.com/college/eldenburg).000 $20. I would eliminate number of students because there does not seem to be a positive linear relationship between maintenance cost and number of students. Costs $25. Other cost drivers for total maintenance cost could be number of rooms cleaned.000 $10.35 Brush Prairie High School The data for this problem can be found on the datasets file for chapter 2. Scatter Plot of Maintenance Costs Against Number of Maintenance Hours Worked Maint. number of hours students attend school.000 $5. Dept. Costs $25. Students may have thought of other drivers that could be logically related to cleaning maintenance costs.
06772 Observations 12 Standard Error 965.0261 Standard Error 130954. Therefore. However. maintenance hours is a reasonable cost driver.832184392 Standard Error 1217.061172 Adjusted R Square -0. Utilities cost varies with season not visits.135 + $35.847440356 Adjusted R Square 0.5045837 4.9 244. The p-values on the Tstatistics are very small.247329 R Square 0.68624 0. and rent for this type of facility is usually fixed.508157 0.920565237 R Square 0. it is logical to expect a strong relation between hours worked and cost.74733262 t Stat 9.461245 7. 2.875134 35. E.18E-05 Regression output for maintenance cost and number of students: Regression Statistics Multiple R 0. changes in maintenance hours worked explains more than 80% of the changes in maintenance cost while number of students explains none.36 The Elder Clinic A and B Salaries are always fixed. providing high confidence that both the intercept and slope are different from zero. An unidentified cost driver could have a higher R-Square. Regression results for maintenance cost and number of maintenance hours worked: Regression Statistics Multiple R 0.Chapter 2: The Cost Function 2-37 D. The total cost function is: TC = $9.173 Observations 12 Coefficient s -89867 197.807201 P-value 0.74*maintenance hours worked. It cannot be known for certain whether the number of maintenance hours is the best cost driver because every single possible cost driver cannot be identified.796328319 Intercept X Variable 1 Coefficients 9134.0857 Intercept X Variable 1 t Stat -0. The most current value is used to .03271 Standard Error 3019. it is considered fixed.438328 According to the R Square statistics.63E-06 2.453062 P-value 2. it is rational to conclude that hours worked will provide a reasonable estimate of future costs. From the analyses performed.
49 Cost Driver Patient-visits Mixed X 2. Given the preceding computations and cost summary. These would be variable. Therefore.07*940 = $25.wiley. Here are some of the reasons: • The managers will not know how many visits they will receive. other facilities may open or close. but not proportionately.441.736 + $6. current illnesses that are circulating in the area. the cost function is: TC = $19. and costs go up as patient-visits increase. There are many possible reasons that could be listed. Visits are affected by season. These would be fixed. There is no one answer to this part. E.100 226 664 $19. **Using high-low.80 D.49 ($3. . This analysis suggests that there are some of the other expenses are variable costs and some fixed. so this cost is classified as a mixed cost. such as tongue depressors. Sample solutions and a discussion of typical student responses will be included in assessment guidance on the Instructor’s web site for the textbook (available at www.07*patient-visits C.412 1.182 = F + $3.115 219 3.736 + $6. Category Medical staff salaries* Medical supplies used** Administrative salaries Rent Utilities Other expenses Total Expenses Fixed $14. Medical supplies vary with number of patient-visits. or there are changes in treatment procedures for certain illnesses.182 .2-38 Cost Management predict next period’s utilities. Also. affecting the number of visits at this clinic. Other expenses appear to increase and decrease with number of patientvisits. Use March. At 940 patient-visits. and so on.49*849. variable cost is $3.$2. to find fixed: $3. such as snake anti-venom. • Prices of all inputs could change (usually increase). Some supplies.736 Variable $3. and so on. high point of medical supplies cost and patient data. weather. each patient requires a certain number of supplies. medical supplies is a mixed cost. • Treatments and related costs may change as new drugs are available.934)/(849 – 778). July expenses are estimated to be: TC = $19. Use the same method for other expenses. new equipment is acquired.58 $6. gloves.com/college/eldenburg).07 Patient-visits X * The value in June is used for fixed costs because the increase in salaries will hold into the future. must be kept on hand whether or not they are used.
If the service is housed in a common building. depreciation schedules. and other miscellaneous costs. Number of work stations might come from the department head. supplies. could be used to identify costs for building and occupancy costs. If not. number of work stations. Some costs are discretionary. a personal budget estimation problem is similar to the cost estimation problem for a business. Number of calls might have to be tracked by employees or by the telephone system. a two point method might be best. Possible cost drivers include number of calls handled. prepaid insurance schedules. Vendors. number of employees. E. D. Accounting records could be accessed to determine the wage rates and time worked for help support staff and supervisors. This data could be found in the accounting system. It would be useful to obtain several years of monthly data from which to prepare scatter plots and run regression analysis. If the help line is housed in its own building. rent). Information about number of employees and hours worked is found in the payroll accounting system.. C. The answers to these questions depend on the individual student’s data and cost behavior. Some future costs can be estimated with high accuracy based on prior commitments (e. department heads. B. The cost object is the help line.38 Personal Cost Function A. . or total number of Internet customers. number of hours worked. If enough data points are available. C. cost allocation records could be used to identify past costs. B. Alternatively. and others could be interviewed to identify any potential cost increases or other expected changes in cost behavior from prior periods.37 Cost function Judgment and Method A. Regression analysis makes use of all data points and is more accurate than twopoint methods. or it might need to be estimated if it has not been tracked in the past. etc. and D. Other costs are highly uncertain and subject to external factors that cannot be controlled. The choice of information sources depends on how the past cost information is to be used. regression analysis would probably be the best choice. Number of customers is part of the revenue accounting records. with representative points selected from a scatter plot. assuming a linear cost function. analysis at the account level could be used to develop a cost function using information from the general ledger.g. Analysis of general ledger entries could be used to determine past costs for phone service.Chapter 2: The Cost Function 2-39 2. In some ways. 2.
the first month is adjusted even though it is not an actual cost: 4.750 68.300 + 36 + 36 + 36 + 36 + 36 + 36 + 36 Other Payroll3 Adjusted Cost $68.800 . A spreadsheet showing the solutions for this problem is available on the Instructor’s web site for the textbook (available at www.39 Smeyer Industries The data for this problem can be found on the datasets file for chapter 2.236 69.800.500 38. B.wiley. but there is insufficient information to make an adjustment.2-40 Cost Management 2.800 41. 1/2 of August 5 payroll goes to July: 5.000 + 500 + 500 + 500 + 500 + 500 Depreciation(b) +$36 1 + 36 -4.200 Apr 71.736 67.750.300/10 x 12 = 35. Operations in the month of July are not typical of the rest of the time period. Similarly. Because of the large difference between these values and the values in other months.com/college/eldenburg).4.790 80.376 65. July’s result is an outlier and should be removed from the data.686 71.750 + 4.8 x 6.036 68. The miscellaneous supplies account also looks suspicious. A. these are correctly handled.200 +$2.596 73.83/mo.350 68. 80% of September 2 payroll to August: . .286 68. as shown in the scatter plot below.150 73.750 . (rounded to $36) 2 Note IB-4's power added to Dept.000 = 4.310 70. No adjustments are needed for items (c) and (d).10. the trend line is likely to distort costs.736 To predict future overhead.500 x 1/2 = 2.wiley. IP-14 3 Payroll paid every two weeks.com/college/eldenburg). If these observations are included in the regression analysis.486 68.2. available on both the Instructor and Student web sites for the textbook (available at www.850 2 .250 May June July Aug Sept Oct Nov 1 Property Tax(a) +$500 + 500 + 500 + 500 -3. Adjustments to more accurately reflect overhead costs incurred: Unadjusted Overhead Mar $68.
000 $50. According to the details provided for August and September.818 6.789722 t Stat 0. Thus.Chapter 2: The Cost Function 2-41 Scatter Plot of Adjusted Overhead Costs Against Direct Labor Hours $75. Here are the regression results: Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations 0. Monthly overhead costs for supplies may be significantly overstated or understated .641981 0.000 6.412139 0.000 $45.000 Overhead Costs $70. Therefore.000 3.775388 0.79 * direct labor hours This cost function might not provide a very accurate estimate for future costs because the direct labor hours explain only about 31% of the variation in overhead costs (based on the adjusted R-square).314163 1980.47 8 Standard Error 29406.050976 P-value 0.000 $40.298502 2.000 $60.086126 Based on the t-statistic and p-value for the intercept.310484 Intercept X Variable 1 Coefficient s 8777. D.000 2. Based on the variation in dates at which supplies are recorded.000 $55.26 3. supplies were a large proportion of overhead cost.000 $65. considerable future variation in overhead costs is likely to occur due to factors other than changes in direct labor hours.500 8. the cost function is estimated as: Overhead cost = $6.500 Outlier Direct Labor Hours C.000 9. the fixed cost does not appear to be different from zero.500 5. they are most likely recorded at the time of purchase rather than at the time of use.
Thus. power costs could be adjusted upward if utility rates in the future are expected to be higher than in the past. these variations would need to be considered. In addition. However. Prior cost data should be adjusted for these changes before the data are used to estimate future costs. Third. Following are three reasons for making adjustments when estimating cost functions.2-42 Cost Management if the amount of supplies inventory varies significantly from month to month. the accounting records might not accurately reflect the costs incurred during each time period. Second. If the cost function is for annual costs. small adjustments that may be material when estimating a cost might not be sufficiently material to the financial statements for adjustments in the accounting records. E. The process of preparing financial statements often includes adjustments so that costs are recorded in the correct time period. Additional adjustments include any expected changes in costs from prior periods. there could be seasonal variation in costs such as overtime pay and utilities. First. this may not be a problem. . adjustments could be made to adjust the balance in supplies inventory each month. For example. financial statements may be prepared less frequently than data is collected for cost estimation. but if the company would like information about predicted monthly costs. sometimes known changes have occurred in prices or cost behavior.
sometimes the cost of obtaining a better measure exceeds the benefits. For example. variable or mixed. A cost function estimated from past cost data may be unreliable if future operating activities are expected to occur in a different relevant range. how to categorize costs as fixed. whether past cost behaviors will continue in the future. C. B.Chapter 2: The Cost Function 2-43 BUILD YOUR PROFESSIONAL COMPETENCIES 2. Fixed costs are often irrelevant to decisions. See Exhibit 2.40 Focus on Professional Competency: Measurement A. A measurement is reliable if it if it is reasonably free from error and bias. and multiple regression (Appendix 2A). If the cost is believed to be nonlinear. A measurement is relevant if the resulting cost function information helps decision makers choose between alternative courses of action. which typically involved creating a cost function for one or more individual costs. simple regression. the main focus was on measuring costs for a cost object. Uncertainties prevent identification of single “correct” measurement methods. It is also necessary to evaluate the quality of measurement results when using accounting information. the best choice of estimation technique. Suppose a cost function is measured for the purpose of estimating future costs. A measurement is appropriate if it is suitable for the purpose. 4. and they prevent complete accuracy in making accounting measurements. two-point method. whereas variable costs are often relevant. For example. which factors drive variable costs. In Chapter 2. high-low method. . for example. Thus. b. it is necessary to use judgment when choosing and applying measurement methods. analysis at the account level. 3. a cost function should distinguish between fixed and variable costs. Chapter 2 introduced the following measurement methods for estimating a cost function: Engineered estimate of cost. relevant. c. 1. and reliable measure for estimating a cost function because of uncertainties about: data availability. then simple regression is inappropriate. 2. It is often difficult to identify an appropriate. When estimating a cost function: a. The costs and benefits of alternative measures should also be considered. in Chapter 2 pointed out that a cost function is estimated within a relevant range of activity. A measurement method such as simple regression is appropriate if past cost patterns are expected to continue in the future and i the cost is linearly related to the cost driver.17 for the pros and cons of each method. and how to interpret computational results.
students might think of others. • The use of technical language should depend on the audience.2-44 Cost Management 5. However. It is typically appropriate to use more technical language in reports written for other accountants than in reports written for non-accounting audiences. Here are some desirable characteristics of a report about an estimated cost function. However. taking into account the knowledge and interests of the user. It is important to present the cost function information objectively to improve its relevance and reliability for the user.9). clear. If the report will be presented to a superior within the accounting department. Changing circumstances can change the patterns of cost behavior and cause an estimated cost function to be inappropriate. the manager should be informed about key uncertainties or risks associated with using the cost function. • The format should be concise. then it may be more important to provide the cost function information rapidly than to prepare a high quality report. then the details of the estimation process may be irrelevant. the user should be informed about the priorities used in creating the report. and/or unreliable. . D. Note: Some of these ideas were adapted from the Path to Higher-Quality Management Decisions presented in Chapter 1 (Exhibit 1. • The report should focus on information that will be relevant to the user. • The desired quality of the report should be weighed against the timeliness of information for the user. If the report will be used by a manager who needs to estimate future costs. and easy to understand. If the user needs to make a decision quickly. irrelevant. People who lack objectivity are likely to present biased information that impairs high quality decision making. then it should probably describe all of the major decisions involved in developing the cost function.
. students are likely to struggle interpreting and choosing a method (Parts E and F).wiley. In prior years. available on both the Instructor and Student web sites for the textbook (available at www.848277 8. Here are the simple regression results: Regression Statistics Multiple R 0.957296 Standard Error 6710. Because of the annual pay increases.5917832 Standard Error 6216. However.wiley.com/college/eldenburg).678620854 Intercept X Variable 1 t Stat 19.3147402 P-value 3. A spreadsheet showing the solutions for this problem is available on the Instructor’s web site for the textbook (available at www. the prior labor costs are biased downward—future labor costs are expected to be higher than past labor costs.02E-10 Based on the regression results.41 Integrating Across the Curriculum: Statistics [Note about problem complexity: This homework problem was written with adequate instructions so that students should be able to perform the various regression analyses that are called for.437E-24 1.609693 1. B. Considerable variation in labor costs is not explained by changes in the volume of production. A. the regression explains only about 59% of the variation in labor costs.194 + $13.04 13.6004687 Adjusted R Square 0. using monthly data for the prior 4 years. the cost function was estimated by regressing actual labor costs on number of chairs produced. The cost function is estimated as: Labor cost = $133.com/college/eldenburg). Also.Chapter 2: The Cost Function 2-45 2.96 x number of chairs produced However.7748991 R Square 0.] The data for this problem can be found on the datasets file for chapter 2. the fixed cost and the variable cost per unit are each positive and statistically different from zero.7995 Observations 48 Coefficient s 133194. the degree of downward bias is higher for older data than for more recent data.
09577 6.486389 P-value 4.02 Adjusted Labor Cost $220.863839 Standard Error 3742.533 x (1.23 x number of chairs produced This regression provides a more reasonable cost function than the previous version because it explains a higher proportion of the variation in labor costs (adjusted R-square of 0.2-46 Cost Management C. Here are the multiple regression results: Regression Statistics Multiple R 0. The fixed cost is nearly the same. D. which is reasonable given the increase in wage rates over time.905 Observations 48 Coefficient s 133736 16.347 Calculation $203.54295 Standard Error 5689.932541 R Square 0.05E-27 2.57E-23 2.742261 Standard Error 5148.23 per chair.891 1. the fixed cost and the variable cost per unit are each positive and statistically different from zero.96 to $16. this cost function would result in a higher estimate for future costs.492 1.864722 R Square 0.010513 1. Here are a couple of months’ data for double-checking the calculation of adjusted labor costs: Month Original Labor Cost Jan 20X1 $203. The cost function is estimated as: Labor cost = $133. approximately 26% of the variation in labor costs is still unexplained. here are the regression results: Regression Statistics Multiple R 0.347 x 1.8 16.06236 11. Nevertheless.91E-08 .533 Dec 20X4 196.274 Using the adjusted labor cost data.73E-20 5.35E-15 Based on the regression results.747745 Adjusted R Square 0.311 200.02)4 $196.869633 Adjusted R Square 0.390275 Intercept X Variable 1 t Stat 24. but the variable cost increased from $13.26499 6.67711 P-value 1.74).23439 Standard Error 5557.736 + $16.00872 Intercept X Variable 1 X Variable 2 t Stat 18. Also.411 Observations 48 Coefficient s 107748.93821 16.
F.26 x current month number of chairs produced + $6. it often takes time for the company to hire qualified new workers.l6 for each chair produced during the month. According to the multiple regression results. then this month’s labor costs will reflect a lower level of labor cost. the fixed cost and the variable cost per unit for each cost driver are all positive and statistically different from zero. However. The first slope coefficient ($16. then this month’s labor costs will reflect the higher level of labor cost. the company’s policy is to increase the number of workers when production volumes increase. it could be argued that some other cost driver might do a better job of predicting future labor costs. There is no one single answer to this question. On the other hand. The cost function is estimated as: Labor cost = $107. the two cost drivers together explain a very high proportion (86%) of the variation in past labor costs. each month’s labor costs are expected to increase by $6. it appears that both independent variables should be included in the cost function because they both have a logical cause-and-effect relationship with labor costs. there may be some lag between the time that production volumes change and labor costs change. .54 for each chair produced during the prior month. Thus. if the prior month’s production was lower than this month’s production. E. Conversely. If the prior month’s production was higher than this month’s production.26) is interpreted in a straight-forward way. In addition. The second slope coefficient requires more thought. and to decrease the number of workers when production volumes decrease.54 x prior month number of chairs produced The statistics suggest that this is a more reasonable cost function than the previous version because all coefficients are positive statistically different from zero. As explained in the problem.749 + $16. and they both have positive and statistically significant coefficients. On one hand. each month’s labor costs are expected to increase by $16. and this regression explains more of the variation in labor costs (86%). and the managers often delay laying off employees when volumes decline.Chapter 2: The Cost Function 2-47 Based on the regression results.