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Sections

  • 2.11 Computer Manufacturer
  • 2.12 Frida’s Tax Practice
  • 2.13 Linear, Stepwise Linear, and Piecewise Linear Cost Functions
  • 2.15 Tax Plus
  • 2.16 Bison Sandwiches
  • 2.17 Glazed Over
  • 2.18 Yummy Yogurt
  • 2.19 Pizza Shop and Fishing Boat
  • 2.20 Hamburger Haven
  • 2.21 Spencer and Church
  • 2.22 Cost Function Using Regression, Other Potential Cost Drivers
  • 2.23 Central Industries
  • 2.24 Big Jack Burgers
  • 2.25 Scatter Plot, Cost Function Using Regression
  • 2.26 Susan’s Telephone Service
  • 2.27 Fancy Furniture
  • 2.28 Wildcat Lair
  • 2.29 Polar Bear Ski Wear
  • 2.30 Firm A and Firm B
  • 2.31 Belford’s
  • 2.32 Peer Jets International
  • 2.33 Peer Jets International (continued)
  • 2.34 Software Solutions
  • 2.35 Brush Prairie High School
  • 2.36 The Elder Clinic
  • 2.37 Cost function Judgment and Method
  • 2.38 Personal Cost Function
  • 2.39 Smeyer Industries
  • 2.40 Focus on Professional Competency: Measurement
  • 2.41 Integrating Across the Curriculum: Statistics

Chapter 2 The Cost Function

LEARNING OBJECTIVES
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.

COMPLEXITY SYMBOLS
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)

2-2

Cost Management

QUESTIONS
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.
Total Cost

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.

2.3

2.4

2.5

2.6

Chapter 2: The Cost Function

2-3

2.7

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.

2.8

2.9

2.10

2-4

Cost Management

EXERCISES
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

Of course.000 Total Cost $12. the CPA's time is the product being sold.13 Linear. For the firm to make this cost direct for the personal returns cost object. CPAs do keep detailed time records. TC = $10. so a portion of his or her salary is direct only to the tax department and indirect to the two other cost objects. and Piecewise Linear Cost Functions A. Now notice that the tax partner's salary is considered a direct cost for all three cost objects. Stepwise Linear. The benefits of tracking the cost at that level do not exceed the benefits of the information that would be obtained. the tax partner probably spends some time in non-billable activities. The time records that the tax partner maintains support this cost as a direct cost. the administrative assistant would have to maintain detailed time records as to time spent working on personal returns versus corporate returns.000 + $8. 2.00*Q Graph of Cost Function $14.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. In a service business such as this.000 $11.000 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 .000 $9.000 $8.000 $10.000 $13.

000 + $39*Q .000 Calculate the variable cost per unit using the Two-Point method: Change in cost Change in volume = ($528.000 + $8.000 $70.000 + $8.000 * $44 = $528.2-6 Cost Management B.000 . for Q ≤ 2.00*Q.000 Combining the fixed and variable costs to create the cost function: TC = $60.000 $0 0 1. TC = $25.000 units: $450.000 TC = $35.000 = F + $39*10.000 Graph of Cost Function $80.000 $20.$390.000 * $45 = $450. Convert the average costs to total costs for each production level: Total cost at 10. To estimate the costs at another production level.000 2.000 – 10.000 . it is first necessary to estimate the cost function.000/2.000 Total Cost $50.000 F = $450.000) = $78.000)/(12.00*Q.000 = $60.000 Total cost at 12.000 Number of Units C.000 4.000 units = 12.000 $40.000 $30.000 = $39 per unit Use one data point in the total cost function and solve for F: Using the data for 10.000 $10.000 3.000 units = 10. for Q > 2.$450.000 $60.

000 0 500 1.000 + $10.000 $45. Inserting $10.000 = $60.500 2.500 2.00*Q .000 + $10.000 + (1.000/15.000: TC = $50.00*(Q-1.00) + $9.000 $60.000 + $585.000 + $9.000 = $9.Chapter 2: The Cost Function Estimated total cost at 15.000 $70.000 * $10.000 + 45%*$10.000 1.00*Q 2-7 Graph of Cost Function $75.000 TC = $51.00*Q.000 For Q > 1.000) TC = $50.000 + $9. for Q < 1.000 $55.000 + $39*15.14 Piecewise Linear Cost Function A.$9.000 Estimated cost per unit = $645.000 $50. TC = $50.000 = $645.000 = $43 D.000 $65. total cost is estimated as: TC = $5.000 units: TC = $60.000 in revenues into the cost function.000 Number of Units Slope is $10 per unit Slope is $9 per unit Total Cost .

then the cost function would appear to be: TC = $51. If the data estimation points occurred across the two relevant ranges.000 units.4. If all of the data estimation points occurred when Q was ≤ 1. 3.2-8 Cost Management B.3219 Y = 4. This cost function will either overestimate or underestimate costs for almost any level of Q (see Exhibit 2A.000 units. then the cost function would appear to be: TC = $50. There are three general situations: 1.00*Q.000 units but would overestimate total cost for Q > 1. the cost function mismeasurement depends on the values of Q.000 units. If all of the data estimation points occurred when Q was > 1. 2. Graph of Learning Curve Cumulative Average Hours Per Return 7 6 5 4 3 2 1 2 3 4 Cumulative Number of Returns Prepared . This cost function would provide reasonable estimates for Q > 1.80/ln2) = −0. then the cost function would be some mixture of the functions for the two relevant ranges.15 Tax Plus A. Hours for two returns would be determined as follows.000 + $9.000 units. using the learning curve equation Y = α Xr Learning rate = 80% α = 6 hours X (units produced) = 2 Learning rate = (ln 0.00*Q. 2.8 hours (average time for each of the next two returns) B. If the accountant did not detect that there were two different relevant ranges.000 + $10. This cost function would provide reasonable estimates for Q ≤ 1.3 and 2A.000 units but would underestimate total cost for Q ≤ 1.3219 Y = 6 hours*2-0.

if time is not traced to individual bowls (for example. F Assuming that employee time can be traced to each bowl. F . it improves less quickly for the next return. D.25. or 25% of sales Combining fixed and variable costs. then wages would be an indirect cost. Total clay cost will vary with the number of bowls made. Depreciation on the kilns is indirect because it cannot be directly traced to individual bowls. In addition. Wages are fixed because they remain constant (the employee always works 40 hours). then variable cost per dollar of revenue is calculated as follows: $8.000 = 0. Note: Depreciation using a method such as declining balance is not constant over time. V C. However. 2. their productivity increases. making it a fixed cost.000 on total sales of $32. Assumptions: Fixed costs remain fixed within the relevant range. and variable costs remain constant within the relevant range. wages are a direct cost. it is a common cost of production for all of the bowls that are heat-treated in the kiln. 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.17 Glazed Over [Note about problem complexity: Items F and H are coded as “Extend” because judgment is needed for categorization. Assuming that the cost of clay can be traced to each bowl.Chapter 2: The Cost Function 2-9 As the accounting graduates become more familiar with the tasks involved in preparing simple tax returns. as their performance improves. 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. If total variable costs were $8. but would still be considered fixed because it does not vary with production volume.000. this particular cost function assumes that variable costs are driven by sales. the cost function is: TC = $20. Eventually their learning will plateau. it is a direct cost. I. The cost probably does not depend on production volume (assuming depreciation is not based on units produced). 2. and their productivity rate will remain stable. B.16 Bison Sandwiches A.000 + 25%*Total sales B. D or I.000/$32.] A. However. that is.

making it a direct and variable cost. it might not be traced to individual bowls. 2. making it an indirect cost. V Assuming that the cost of packing materials is traced to each bowl. If it is an hourly charge. it is most likely traced to individual bowls. G.300 $3. It is mostly likely a flat fee or is calculated on a basis unrelated to production volume. it is probably a mixed cost. E.000 2. If the kiln is electric. I.] A. if the cost is too small to justify tracing them). Packing costs are most likely variable because they will increase as production increases. I. making it an indirect cost. making them a common cost for multiple units and an indirect cost. They might be fixed or variable. Advertising is not directly related to production.300 Variable $4. D or I. because the production area may need more cleaning as volumes increase. This cost is also discretionary. if the cost is small it might be grouped with overhead costs (variable). making it an indirect cost.000 in sales $1. Fixed Cost of ingredients Rent Store attendant (salaried) Total Costs at $9. F The business license is not related to production. depending on whether they are “used up” after a certain quantity of production. so it is treated as fixed. I. F. this is a direct cost. Also. F I. V or F Brushes for the glaze are most likely used for multiple bowls. I. depending on what causes the cost to vary.2-10 Cost Management D. It might be fixed or mixed. F or M Pottery studio maintenance is an indirect and fixed cost if it is the same payment every week. J. If the cost of glaze is very small.500 ______ $4. V If the glaze is expensive and therefore a relatively large cost. part of the cost might vary proportionately with volume. D or I.500 . then this cost could be indirect. H. making it a fixed cost. F or M Electricity is an indirect cost because it cannot be traced to individual bowls.18 Yummy Yogurt [Note about problem complexity: Item A is coded as “Extend” because judgment is needed for categorization. If the packing materials are not traced (for example. I.

workers’ compensation. In the pizza shop. they are more likely related to time on the boat than pounds of fish. Therefore. employees are likely scheduled in advance on a fixed schedule. In the fishing boat business. because of uncertainty in the success of each fishing expedition.500/$9. or M There would most likely be hourly wages in both types of businesses (assuming employees are hired). this cost would most likely be fixed because the cost would not vary within a relevant range of activity. and unemployment insurance. FB. In many organizations. The opportunity cost is the contribution margin from the products sold with the flavor that has been replaced. and G are coded as “Extend” because they require substantial business knowledge and/or ability to visualize cost behavior. F. F or M Employee benefits occur in any business in which employees are hired. In this type of situation. D. the cost function is: TC = $3. F There would be no reason to incur fishing equipment costs in a pizza business. D. PS. B. as well as voluntary items such as health insurance and retirement benefits. total revenue (TR) instead of quantity (Q) can be used in the cost function: Total variable cost/Total revenue = $4. The cost of rent is irrelevant because it will not change with either alternative. so they would tend to be fixed or mixed (see Item A above). 2.Chapter 2: The Cost Function 2-11 B.19 Pizza Shop and Fishing Boat [Note about problem complexity: Items C. or 50% of revenue Combining fixed and variable costs. .] A. There most likely would not be any ingredients in a fishing boat business. B. V. E. F. V Ingredients are used in making pizzas. C.300 + 50%*Total revenue C. Benefits might include mandated items such as social security. and the cost would vary with number of pizzas produced. B. Hourly wages on the fishing boat most likely vary with the number of days or hours the boat is out fishing.50.000 = 0. While hourly wages may be related to number of fish caught. costs vary with dollars of revenue. Benefit costs often vary with level of wages or salaries. Some may be sent home if business is very slow. these costs would be mixed with a large proportion of the cost fixed.

G.1075 3.1075 0. Cost of plain burger = $0. 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.1619 0.0148 0. 2. but it might be mixed if a portion of the cost relates to levels of business activity.0198 9.0233 7. Dill pickles [($8.0863 5. In general.0179 4. Mayonnaise [$1.5195 = $1.49/(16 x 4)] 0. and yellow pages advertisements. B. although the cost would probably be much higher for the pizza business because of the utilities needed to run the pizza shop. advertising costs would be incurred. Tomato ($. there might be some utility costs for the fishing operation and for a business office. the utility costs for these two businesses would tend to be fixed (would not vary with production). The cost might be fixed or mixed.0179 0. F. Catsup ($.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 1.59/16) 0.000) * 4] 0.2414 $0.15/45) 0.0198 0.99/50) 0.69/7) $0.0033 0.2414 2. F Most pizza shops incur advertising costs such as flyers. F or M Any type of business will have insurance costs. Because advertising costs tend to be discretionary.6815 A. Cheese ($2.59/40) 0.6815 .69/8) 0.2-12 Cost Management E. Hamburger patty ($1.5196 Suggested selling price: 300% * $0.29/12) 0. F Some type of utility costs (such as water and electricity) would be incurred in both types of business. newspaper advertisements. If the fishing boat is for tourists.2414 $0.95/2.1619) = $0. Lettuce ($.0053 8. PS.0233 0. Mustard ($. depending on how the insurance cost is calculated.79/150) 0.1619 10. B. Hamburger bun ($1. For the fishing boat business.56 .0863 0.0148 6.3489 (calculated above) B.$0.0053 0. Onions ($.0033 $0. Cost of burger with everything except cheese = ($0.3489 $0. they are treated as fixed costs. It will be a fixed cost if it is a flat amount.1075 0.

that is.79 Some students will view this higher price as "unfair. Market forces will dictate achievable prices. Professional subscriptions.] A. Professional dues. The Step 2 questions (A.6815 = $2. Alternatively. Long is able to differentiate her hamburgers from others in the market. most organizations are price takers. she needs to know what competitors charge for a similar quality sandwich and price hers competitively. volumes will drop because customers will go to other fast food restaurants that sell hamburgers.04 .Fixed E. she foregoes profits and people may believe there could be quality problems with her food. B.Chapter 2: The Cost Function 2-13 C.25 = $1.Mostly fixed and discretionary H. Office supplies .04 Therefore. 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. Clerical wages – Fixed unless overtime is regularly scheduled.Mixed. and F) are the ones requiring significant assumptions to generate an answer.Fixed F. in which case the total cost would be primarily fixed. It is just a general guideline. that cost would be variable. if her prices are too low. Long’s prices are too high." However.Fixed . Rent . the price of the plain hamburger should be: $2. This means that her costs need to be below the competitive price. However staff are often salaried. Licenses. B. Staff wages – Could be variable or mixed (salary + overtime) for regular staff. D. mostly variable G. If Ms. they set prices considering their competitors’ prices. Therefore. if Ms. Alternatively. there is no moral obligation to maintain a 300% markup on each item. 2.21 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.Fixed D.Fixed and discretionary I. and then mixed C. In the current business environment. Selling price of cheeseburger with everything: 300% * $0.$0. If there is part time help. Property taxes. FICA taxes (Social Security taxes) – Mixed – mostly fixed because most employee wages would be fixed J. Insurance.

The cost analyst needs to gather information about how marketing costs are set each year. 2.22 Cost Function Using Regression.com/college/eldenburg). The adjusted R-Square indicates how much of the variation in the marketing department cost can be explained by variation in units sold. .wiley. For example. If this is the case. TC = $222. C. A spreadsheet showing the solutions for this problem is available on the Instructor’s web site for the textbook (available at www.) B. Other Potential Cost Drivers A. or profits.2-14 Cost Management K. the variation in units sold explains about 61% of the variation in marketing department cost. number of advertisements placed. the analyst could ask the CFO whether the marketing department budgets its costs through a negotiation process with top management.35*units sold. available on both the Instructor and Student web sites for the textbook (available at www. In this problem.com/college/eldenburg). (Notice that the T-statistics on the fixed costs indicate that it is not likely to be different from zero. Therefore. the cost is discretionary and will be set through the negotiating process. Advertising – Fixed and discretionary 2.wiley. it is possible that marketing costs are discretionary.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 fixed cost is set at zero. Other possible cost drivers for marketing department costs could be revenue. In addition.] The data for this problem can be found on the datasets file for chapter 2.

000514 .58E-05 0.000 $1.119724 15 Coefficient s 884.500 $1.582691 P-value 6.58824812 182. Potential Cost Driver: Output Maintenance Costs Against Output $2.4342166 0.113687834 Intercept Output t Stat 5.500 Maintenance Costs $2.78591283 0.000 $500 $0 0 500 1000 Output 1500 2000 Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations 0.Chapter 2: The Cost Function 2-15 A.52099624 Standard Error 153.761602 4.026826 0.61765897 0.

60187065 0.36224828 0.2-16 Cost Management Potential Cost Driver: Direct Labor Hours Maintenance Costs Against Direct Labor Hours $2.500 $1.017601 .500 Maintenance Costs $2.457384 3.31319046 235.005847 0.291084 2.000 $1.717372 P-value 0.02569657 Standard Error 261.113464425 Intercept Direct Labor Hours t Stat 3.000 $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 0.210849 15 Coefficient s 861.7549386 1.

6778973 0. However.357393 15. This indicates that the cost could be totally variable.96E-10 B.Chapter 2: The Cost Function 2-17 Potential Cost Driver: Machine Setups Maintenance Costs Against Machine Set-Ups $2. For example.815737 29. a good cost driver would present a linear or football-shaped positive slope or trend. Sometimes a cost that is mostly variable can be identified from a scatter plot. If the observations are widely scattered. . machine setups appears to be the most likely cost driver and direct labor appears to be the least likely cost driver.94888217 0.42597461 1.197755 8.97410583 0.5343 P-value 0. In Part A. the trend line for machine setups looks as if the intercept could be zero or very close to zero. In a scatter plot.000 $1. all three potential cost drivers appear to be positively related to maintenance costs. or the cost is mostly fixed.5913391 15 Standard Error 93.910475729 Intercept Machine Setups t Stat 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 126.94495003 66.500 $1.500 Maintenance Costs $2. the cost driver does not explain the variation in cost and either it is the wrong driver.

E.945. . Changes in many factors such as resource prices. business processes. the cost is likely to be totally variable.945 Cost Function TC = $884 + $0. so it is excluded from the cost function. the economic environment. The regression using machine setups has the highest adjusted R-Square of 0. This provides confidence that the variable cost part of the cost function is not zero.025*Direct Labor Hours TC = $29. This means that variation in setups explains about 95% of the variation in cost. R-Square 0. The regression results and cost function for the three potential cost drivers are: Potential Cost Driver Output Direct labor hours Machine setups Adj.2-18 Cost Management C. Therefore. but does not provide confidence that the intercept (fixed cost) part of the cost function is different from zero. the t-statistic is significant for the independent variable but not for the intercept. In the machine setups regression. and technology can cause future costs to be different than estimated.68* Machine Setups The machine setups intercept coefficient is not significant.313 0.588 0. D. 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.521*Output TC = $861 +$3.

which could be outliers. not represent the cost most of the time.100 – $632. the total cost function is: TC = $11.000 = 0.100) = $25. that is.333)/($1. That means that the cost function might not represent the actual cost.$56.132. or 5% of sales The fixed cost is determined by substituting the variable cost into one of the high-low data points: $68.333 .100 F = $68.605 = $11.728 + 5%*Sales B.132. the variable cost is calculated: ($68. this cost function might provide poor estimates of future costs. on average.24 Big Jack Burgers A.728 Thus.333 = F + 5%*$1. Under the high-low method. the cost function is calculated using the highest and lowest values of the cost driver.05.000/$500. Total revenue (TR) instead of quantity (Q) in the cost function because sales is a potential cost driver. The high low method uses the most extreme cost driver values. . Therefore.333 – $43. First.Chapter 2: The Cost Function 2-19 PROBLEMS 2.

000 $0 $0 $300.200.000 $20. Then. the cost function would be: TC = 4. Alternatively. Chart of data with trend line added by Excel.000 Sales It appears that the cost is most likely mixed. but the p-value is greater than 10% at 0. Then. Notice that the t-statistic for the intercept coefficient is 2. trend line extended to Y-axis (dashed line) using Word: Scatter Plot With Trend Line $80.172. the cost function would be TC = $16. D.800 + 4.000 $600. Additional judgment is required to decide whether it is appropriate to include a fixed cost in the cost function.2-20 Cost Management C. Based on the p-value.000 $40. analysis at the account level might indicate that there are few fixed costs. 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.000 $900. Because this regression has few observations.000 $1.5% x sales. If this cost pool includes items such as salaries and other fixed costs (insurance. There is a general downward slope (variable cost) that appears to meet the intercept enough above zero to suggest a fixed cost. etc). fixed costs are likely to be zero and would be excluded from the cost function. Following is the regression output. The upward slope of the line indicates that there are variable costs.162.000 Administrative Costs $60. Analysis at the account level can be used to increase the understanding of this cost. there is a 16% probability that the intercept (fixed cost) is not different from zero. In that case.5% x sales . the p-value result for the tstatistic is atypical.

especially because so few observations were used in the estimation.365 + 0. there does appear to be a general upward trend. This method can be used in cases where there is not enough data to perform regression.9680477 0. There might be a large discretionary component in administrative costs. There might be a change in business operations or in the economy that would cause future costs to be different than in the past.0319523 Intercept X Variable 1 E. The plot shows costs that are widely scattered.00818212 t Stat 2. the cost function is: TC = $50.25 Scatter Plot.73545 0. However. If these assumptions do not hold. then both methods may be unsuitable for estimating future costs.16197623 0. Because of unforeseen changes in cost behavior. The adjusted R-Square statistic is very low at 0. If there are more data points. F. however.45937486 P-value 0. Cost Function Using Regression A.04466925 0. 2. The cons of the high-low method as an estimation technique were discussed in Part B above. on average. and it can be further improved by adopting more representative data points than the highest and lowest values of the cost driver. Both methods assume that the cost function is linear and that all data points come from a single relevant range. Therefore.2444 7734. both of these methods assume that the data points are representative of future costs. . causing fluctuations in cost that are unrelated to any cost driver. the high-low method may be the best option available.17205158 5. and possible changes in costs such as those described in Part E are ignored. This means that variation in sales explains only about 18% of the variation in research and development cost.90567454 3293.82%*Sales C.Chapter 2: The Cost Function 2-21 Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations 0. the results rely on more complete information and provide a better estimate. If there are only two or three data points. B.186. Sales does not appear to explain much of the variation in research and development costs. a cost function may not provide a good estimate for the next month’s costs. regression analysis incorporates all of the observations into the analysis. Using the regression results. Unusual cost items are assumed to continue in the future. Future costs are not likely to be estimated accurately if the cost driver explains only a small part of the variation in the cost. In addition.93711636 0. Sales might not be the activity that drives administrative costs.4038 4 Coefficients Standard Error 16800. The past costs used for estimation might not be representative.

Regression is useful for estimating a cost function when fixed and variable costs are unknown. part of the cost is committed and cannot be reduced. The cost driver for long distance calls is the number of minutes on the telephone. Since she has to have telephone service to stay in business. Since she probably can cut back on calls when her consulting work is not providing enough income. 2. It is likely that Susan has to call people to conduct business. that is. The fixed cost is the $20 flat fee. Yes. F.2-22 Cost Management D. In addition. the number of calls and whether they are long distance or local calls will vary. although she could use email. In this problem. Since her consulting work varies. assuming that the cost function is linear may not be appropriate. the relation makes sense from an economic standpoint. the underlying cost function is assumed to be linear and that the cost driver is assumed to be economically plausible as a cost driver. on average. The scatter plot shows little evidence of linearity. When regression analysis is used to specify a cost function. In this problem. as she has in the past. The variable cost is 10 cents per minute for those minutes over 500 per month. Susan already knows the cost function. First. E. 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. usually annually. C. D. research and development cost is often discretionary. She cannot be certain that she will use the same amount of time.26 Susan’s Telephone Service A. B. the amount of traveling she will be doing since she cannot call from home when she is traveling. Managers set the costs depending on the organization’s strategies and funds available for research and development. Several very general assumptions apply to a linear cost function. Therefore. the cost is assumed to be linear within the relevant range. Additional information could include the location of Susan’s future consulting work. so she does not need to estimate the cost function using regression or any other estimation technique. 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. It also depends on whether she can trace telephone calls to individual . G. H. a portion of the cost is likely to be discretionary. fixed costs would remain fixed and variable costs would remain constant within that range. These costs are set by decision. the cost of alternatives such as cellular service or any other types of telephone or communication service. to make a decision she needs to compare her costs under the old plan to what costs would be under the new plan.

using the learning curve equation Y = α Xr α = 10 hours X (units produced) = 4 Learning rate = (ln 0.90/ln2) = −0.27 Fancy Furniture A.057 The average cost is lowest at exactly 500 minutes per month. In . Many cellular telephone bills do not list the calls made. so Susan may need to maintain her own records if she wishes to trace telephone usage.152 Y = 8.05 $0.04 $0. In most businesses.00 $20. If her calls are over 400 minutes or under 600 minutes. In this case the learning rate would be wrong and so the time would also be wrong. Minutes 300 400 500 600 700 Total Cost $20.067 $0.00 $20.Chapter 2: The Cost Function 2-23 consulting jobs.05 $0. Here are some of the reasons. I. students may think of others.00 $20.00 $20. It is possible that the managers under.1 hours (average time for the first four batches) B.00 + (600-500)*$0. Hours per batch would be determined as follows. telephone costs are viewed as an indirect cost. 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.10 = $30. There are many different reasons that the time could be different from the amount determined above. 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.10 = $40.152 Y = 10 hours*4-0. she will pay a very high rate of 10 cents per minute 2. her phone bill will be less than it would be at a rate 5 cents per minute. Cons • If Susan has a number of projects in her local area or will be traveling a lot.or overestimated the amount of hand work performed.00 Average Cost $0.00 + (700-500)*$0. which appears to be the other alternative (although the 5 cents per minute rate might not be available for daytime week day calls). she may be paying for 500 minutes of service that she does not use • If Susan’s calling volume exceeds 500 minutes per month.

the cost function is: TC = $47. and the University surcharge is specifically based on sales. Wildcat Lair costs: Purchases of prepared food Serving personnel Cashier Administration University surcharge Utilities Totals Fixed $ 30. 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.000 + 40%*80. and B. However.000 5.000 + 40%*Total revenue D. or has a great deal of experience on the machine. then the chart suggests that the learning rate estimate is reasonable.000 using the cost function is: TC = $47. 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 Total revenue is the most likely cost driver for both variable costs.000 .000 = $79.000 Variable $21. The observations of labor costs over the first few weeks would not be representative of the labor costs once productivity has stabilized. it is possible that different types of wood affect the rate at which chairs can be produced.000 = $1.000 Profit = Revenues – Total costs = $80. 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. If a worker is absent one day. total revenue (TR) instead of quantity (Q) can be used in the cost function: Variable cost = $28.500 $47. Food costs are likely to vary proportionately with sales. Thus. Because revenue is the cost driver for both variable costs.$79.000 7.000 _______ $28. The estimate of total costs given revenues of $80.2-24 Cost Management addition. 2.28 Wildcat Lair A.000 1. C.000/$70. the rate will change if the replacement employee has never worked on this machine. C. or 40% or revenue Combining fixed and variable costs. if managers believe that 25% of the work is done by hand.40. D. then the cost would be overestimated.000 = 0.000 .500 10.

000).) The adjusted cost function is: TC = $47.000).] A.000— the operating loss of $(5. for July the opportunity cost would have been $2. total variable costs are expected to increase by $4.$4. the opportunity cost is estimated to be: Revenue Fixed costs Variable costs (30%*$80.000)+the university surcharge of $7. it would lose the revenues. less the fixed costs and the variable food costs. Variable food costs are estimated to be 30% ($21.000) Net 2. If the university were to close the Lair. the additional profit from a $10.29 Polar Bear Ski Wear [Notes about problem complexity: Item A is not coded as Step 2 because this is explicitly discussed in the chapter.000 increase in revenues is expected to be $6.000 increase in revenues.000 + 30%*Total revenue During August. costs would be higher when there were fewer sales.000 (47. F.000 ($10. So. the variable cost part of the cost function can be adjusted. However. Electricity costs also vary with changes in electricity rates. generating most its sales around the ski season (fall and winter). B. Only total variable costs are expected to increase.000/$70. Thus. C.000) of revenues. so the trend would be the opposite of this plot.000+$6. Because the university surcharge is an allocation within the university.000 (-$5. In a retail business. but this is not considered a cost driver (a business activity that causes variations in total variable cost). To estimate the opportunity cost for August. Assuming the highest electricity cost is during the winter when fewest bathing suits are sold. electricity usually varies with hours of operation and possibly with the season (because of heating and air conditioning). and the increase is estimated to be 40% of the increase in revenues. it might even close when the ski area shuts down. the shop might experience very little business activity. Item D will be VERY difficult for most students. So.000 . A shop located near a ski area is likely to incur high heating costs during the winter.000*40%). Lair’s fixed costs are assumed to be unchanged with the $10.000) (24. 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). if the bathing suit shop is located in a geographic region $80.000.000 .000.Chapter 2: The Cost Function 2-25 E. In July there was a loss of $5. (This is the same as the previous 40% variable cost rate less the university surcharge of 10% of revenues. The shop is most likely a seasonal business.000 ($10.000) $ 9. During the spring and summer months. so the estimated profit in August is $1.

45 $ 514. higher profits generally occur during periods when activity is high.028.69 x 5 = $1. given a 100 unit production level: Y = α Xr Y = $300*100-0.028. using the learning curve equation Y = α Xr α = $300 instead of hours X (units produced) = 5 Learning rate = (ln 0.5 = $152.67 Firm A's income for last year was: Sales Costs Income $1.2345 Y = $300*5-0. Higher profits. Although these expenditures are made because more money is available.2345 Y = $101. 2.84 .67 1.45 x 1. D. in turn. firm B's selling price is: $101. generally mean there is more money available to spend on administrative travel. they are discretionary expenditures and not caused by the level of activity. correlation does not necessarily mean causation.2-26 Cost Management where the highest electricity costs occur during the summer because of air conditioning. special promotions. A correlation may appear in a scatter plot or regression analysis. a 50% markup on total cost will cause sales to be: $1.542.45 Although each customer paid a different price.028.50 = $1.85/ln2) = 0. For example.89 (average cost for each of the 100 units produced) Given a 50% markup on cost.22 Firm B set its selling price based on the average cost. employee training.2345 Y = $205. then the highest sales might coincide with the highest electricity costs. Many costs can be related to volume of activity.30 Firm A and Firm B Costs for Firm A in the first year would be determined as follows. However.69 (average cost for each of the 5 units) Total cost = $205.89 x 1.542. and new office furniture or equipment.

85 x 1.384.028.528.45 $1.75 (average cost for each of the 300 units) Note that the cumulative production for Firm B through this year is 300 units.40 1.727.65) Income Firm A's revenues for this year are: (10 x $152.75) 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 = $9.10 $22.84) = $1.40 Firm A's costs may be computed as follows: Y = $300*15-0. assuming an 85% learning effect would be: Y = $300*150-0.50 $ 9.356.356.97 (average cost for each of the 15 units produced) Total cost to produce the first 15 units (15 x $158.2345 Y= $78.897.85 Thus Firm B's selling price this year was $64.50 $ 9.84) Costs (150 x $ 92.727.028.50/150 units = $64.50 = $97.55 1.65 (average cost for each of the 150 units produced) Firm B's income statement for last year was: Sales (150 x $152.30 $2. Total cumulative production cost (300 x $78.50 .10 $ 172.897.00 13.00 13.50 Firm B's calculation for its selling price is as follows: Y = $300*300-0.2345 (notice that the cumulative units produced is 15) Y = $158.Chapter 2: The Cost Function 2-27 Firm B's costs.28 $23.528.97) 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 $1.625.926.2345 Y = $92.

Such results often lead to charges of "unfair dumping" but with large differences in cumulative production volumes.356. A. 2.com/college/eldenburg).500. Sales seems to be a potential cost driver because there appears to be a positive correlation between the marketing department costs and sales.28 is lower than Firm A's average cost per unit: $1.000 $7. A spreadsheet showing the solutions for this problem is available on the Instructor’s web site for the textbook (available at www.500. available on both the Instructor and Student web sites for the textbook (available at www.592.2-28 Cost Management Firm B's income statement for this year is Sales (150 x $97.wiley.000 $6.50 Note that Firm B's selling price for this year of $97.500.wiley.864.000 Marketing Dept. Costs $165. There is a positive slope.31 Belford’s The data for this problem can be found on the datasets file for chapter 2.000 $145.com/college/eldenburg).00 9.61. .000 $155. and most of the observations appear to have a fairly linear trend.50 $ 4.000 Sales B. Scatter Plot of Marketing Costs Against Sales $175. such extreme differences in cost can occur.10/10 = $135.727.85) Income $14.500.000 $5.28) Costs (150 x $64.000 $8.000 $135.

the cost estimate should not be based on past costs.58184484 13. sales may go up.86656716 Standard Error 4015. Discretionary costs are set by decision. Even if marketing department costs are discretionary.5289E-14 Intercept X Variable 1 Based on the regression results. Here is the regression output.7600071 P-value 2.34%*Sales D.93336396 R Square 0. the cost function is: TC = $65.4501E-10 5.08144 Observations 30 Coefficients 65584.87116829 Adjusted R Square 0.63816 0. F. In addition. When more money is spent on marketing.584 + 1.Chapter 2: The Cost Function 2-29 C. If the variable portion of the marketing cost is sales commissions. Therefore. there would be a positive correlation between marketing department costs and sales. the decision maker(s) should be asked what next year’s cost will be. Assuming that profits are more likely to increase when sales increase.00097028 t Stat 9. E. discretionary costs such as marketing are often increased when profits increase. it is economically plausible for sales to be a cost driver. usually annually. they may be positively correlated with sales.01335108 Standard Error 6844.2608 0. using regression or any other technique. . Instead. Regression Statistics Multiple R 0.

Manufacturing Overhead Against Labor Hours Manufacturing Overhead Cost $200.000 $120.000 $80.2-30 Cost Management 2.wiley. A.000 $0 0 500 1000 1500 2000 2500 Labor Hours Manufacturing Overhead Against Machine Hours Manufacturing Overhead Cost $200.000 $120.wiley.000 $80.000 $160.32 Peer Jets International The data for this problem can be found on the datasets file for chapter 2.000 $40.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. available on both the Instructor and Student web sites for the textbook (available at www.com/college/eldenburg).000 $40.000 $160.000 $0 0 300 600 900 1200 1500 Machine Hours .

either the driver is wrong or the cost is mostly fixed.000 $0 0 100 200 300 400 500 600 700 Raw Materials B. labor hours could be deleted as a potential cost driver. Sometimes a cost that is mostly variable.50852 7. Labor Hours Regression: Regression Statistics Multiple R 0.01272369 Adjusted R Square -0. C. the cost driver does not explain the variation in cost. but the plot for labor hours appears to have the least trend.000 $160. None of the plots show a definite trend.552864 .000 $80.8173 Observations Coefficient s 150410.02253618 Standard Error 11114.86E-11 0.600936029 Intercept Labor Hours t Stat 10. Based only on the cost plots.1543 0.000 $40. Costs and potential cost driver data are plotted to determine whether further analysis is necessary.Chapter 2: The Cost Function 2-31 Manufacturing Overhead Against Raw Materials Manufacturing Overhead Cost $200.682 4. Analysis of the plots involves looking for a linear or football-shaped positive slope or trend.56597156 30 Standard Error 14812. If the observations are widely scattered.000 $120. The plots help determine whether regression analysis should be performed using any of the potential drivers. D.11279932 R Square 0.600712 P-value 6.

411 Machine Hours Regression: Regression Statistics Multiple R 0.9786 Observations 30 Coefficient s 126216.095468 P-value 4.1555 Observations 30 Coefficient s 117598.004579 Both the intercept and slope coefficients are significant.215128 Standard Error 10853.22* Raw materials . so the cost function is estimated as: TC = $150.91 60.11E-12 0.217192 Standard Error 10291.599 + $38.217 + $60.2266685 Standard Error 9665.68E-12 0.4268 4.331580777 Intercept Machine Hours t Stat 11. so the cost function is estimated as: TC = $126.67 38.3522862 Standard Error 8846.56778 19.2533351 Adjusted R Square 0.22*Machine hours Raw Materials Regression: Regression Statistics Multiple R 0.53627459 Intercept Raw Materials t Stat 11.082222 P-value 3.000325 Both the intercept and slope coefficients are significant.47803 9. so the cost function is estimated as: TC = $117.612063 R Square 0.62907 3.3746211 Adjusted R Square 0.5033241 R Square 0.2-32 Cost Management Only the intercept term is significantly different from zero.

976635 Standard Error 10361.com/college/eldenburg). and the adjusted R-Squares from the regressions are: Machine Hours Raw Materials 0.210187 P-value 3.10654585 Intercept Labor Hours Machine Hours Raw Materials t Stat 5.1959303 48.3E-06 0.Chapter 2: The Cost Function 2-33 E. Labor hours can be eliminated as a potential driver because its coefficient is not significantly different from zero (see Part D).226 Based on the simple regression results. F.wiley.33 Peer Jets International (continued) The data for this problem can be found on the datasets file for chapter 2.com/college/eldenburg).wiley.218173 8. A. A spreadsheet showing the solutions for this problem is available on the Instructor’s web site for the textbook (available at www. Multiple regression with all three potential cost drivers: Regression Statistics Multiple R 0.8067018 Standard Error 4832.08E-08 .8266982 Adjusted R Square 0.9092294 R Square 0.489 -0. 2.778501 82.12E-09 1.886218 -0.05878 9.5558 Observations 30 Coefficient s 60988. Yes. available on both the Instructor and Student web sites for the textbook (available at www. machine hours appears to do the best job of explaining manufacturing overhead costs. this driver explains only 35% of the variation in cost.352 0.953575 1. The coefficients for each of the other potential cost drivers are significantly different from zero.333162437 5. however.291558412 10. the direct labor hours was not significantly related to manufacturing overhead costs using simple regression.2349 3.

001) $-0. R2 Simple Regressions: Labor Hours Machine Hours Raw Materials Multiple Regression 0.2-34 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. its coefficient is negative rather than positive in the multiple regression. Both machine hours and raw materials are positive and significantly different from zero when using simple regression and also when using multiple regression.022 0. Multiple regression using machine hours and raw materials as cost drivers: Regression Statistics Multiple R 0. A combination of cost drivers does a much better job of explaining the variation in manufacturing overhead costs than either cost driver alone.352 and 0.001) $4.217 (<0.001) B.55) $38.7422519 82.93*Raw materials D.925842 30 Standard Error 8743.98 (<0. C. Also. its coefficient is not significantly different from zero in either regression. Manufacturing can be a complex activity requiring a number of different tasks. machine hours and raw materials explain different activity .806 $150. labor hours can be eliminated as a potential cost driver. Thus.29E-09 The cost function is: TC = $60.22 (<0. Costs for these activities are likely related to specific cost drivers.001) $117.82667515 Adjusted R Square 0.005) $82.939606 9.352 0.74*Machine hours + $82.678 + $48.411 (<0.881964042 Intercept Machine Hours Raw Materials t Stat 6. In this example.450561 8.157604083 9.78 (<0.57 (0.86E-07 4.81383627 Standard Error 4742.988 (<0.954) $48.71E-10 5.001) $60.20 (0.001) $126.391636 P-value 1. Each task includes different activities. The adjusted RSquare is far higher in the multiple regression (0.22 (0.599 (<0.90921678 R Square 0.226 0. Labor hours does not appear to be a cost driver when using either simple regression or multiple regression.806) than in either of the simple regressions (0.5902 48.226) for these two cost drivers.5348 Observations Coefficient s 60677.664851 5.001) $60.

If they have outdated information and inaccurate information. More importantly. 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. such as machining work on units. 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. If Regina submits unrealistically low budgets this month and then more accurate budgets next month. her reputation would also suffer. B. Although the board is not directly involved in day-to-day operations. However.34 Software Solutions A.Chapter 2: The Cost Function 2-35 costs. The relationship between the CEO and the board should be one of trust and confidence. 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. such as a business expansion. and use last year’s budgets for departments that have not turned theirs in. the board may begin to lose trust in the CEO’s ability to manage operations. and that could reflect negatively on the Finance Director. in their role of oversight. . Regina has at least two choices in this situation. the board may make inappropriate decisions based on faulty data. The board of directors monitors the performance of the CEO and top management. Regina should submit the most current information she has. They may also use the inaccurate information to help them approve decisions. if she submits a budget based on last year’s budget and she knows that this is likely to be inaccurate. They may either praise or criticize top management when the situation may not warrant it. the department amounts and total budget may be quite inaccurate. 2. they will draw erroneous conclusions about the performance of the organization and the top management. and the Director of Finance will present the board with information that is unreliable. 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. they need the most current information available and explanations for information that is not available. C. but with large increases in department costs. She may believe that her reputation as a diligent employee would suffer if she cannot produce something. 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. If Regina uses last period’s budget. and materials handling for the units.

Dept.com/college/eldenburg).000 $20. .000 $0 528 530 532 534 536 538 540 542 Number of Students C. available on both the Instructor and Student web sites for the textbook (available at www.000 $15.35 Brush Prairie High School The data for this problem can be found on the datasets file for chapter 2. square feet cleaned. Dept.000 $0 50 100 150 200 250 300 350 Maintenance Hours Worked Scatter Plot of Maintenance Costs Against Number of Students Maint. number of hours the building is open.com/college/eldenburg).wiley. Students may have thought of other drivers that could be logically related to cleaning maintenance costs.000 $10.000 $15. A.000 $20. Other cost drivers for total maintenance cost could be number of rooms cleaned. Scatter Plot of Maintenance Costs Against Number of Maintenance Hours Worked Maint. Costs $25.000 $10.000 $5. Costs $25.000 $5. A spreadsheet showing the solutions for this problem is available on the Instructor’s web site for the textbook (available at www.wiley. or number of classes and activities per period. B. I would eliminate number of students because there does not seem to be a positive linear relationship between maintenance cost and number of students.2-36 Cost Management 2. number of hours students attend school.

796328319 Intercept X Variable 1 Coefficients 9134. Utilities cost varies with season not visits. 2.06772 Observations 12 Standard Error 965.18E-05 Regression output for maintenance cost and number of students: Regression Statistics Multiple R 0. An unidentified cost driver could have a higher R-Square.36 The Elder Clinic A and B Salaries are always fixed. maintenance hours is a reasonable cost driver.0857 Intercept X Variable 1 t Stat -0.74733262 t Stat 9. E. 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.Chapter 2: The Cost Function 2-37 D.9 244. changes in maintenance hours worked explains more than 80% of the changes in maintenance cost while number of students explains none. However.74*maintenance hours worked.061172 Adjusted R Square -0.508157 0.68624 0.135 + $35.461245 7. and rent for this type of facility is usually fixed.5045837 4. From the analyses performed.247329 R Square 0.920565237 R Square 0. The p-values on the Tstatistics are very small.453062 P-value 2. it is considered fixed. it is rational to conclude that hours worked will provide a reasonable estimate of future costs.875134 35. The total cost function is: TC = $9.0261 Standard Error 130954.03271 Standard Error 3019. Therefore. providing high confidence that both the intercept and slope are different from zero. Regression results for maintenance cost and number of maintenance hours worked: Regression Statistics Multiple R 0.63E-06 2.832184392 Standard Error 1217.807201 P-value 0.173 Observations 12 Coefficient s -89867 197.438328 According to the R Square statistics. The most current value is used to . it is logical to expect a strong relation between hours worked and cost.847440356 Adjusted R Square 0.

07 Patient-visits X * The value in June is used for fixed costs because the increase in salaries will hold into the future. Visits are affected by season. Here are some of the reasons: • The managers will not know how many visits they will receive.182 = F + $3. Medical supplies vary with number of patient-visits. These would be variable.com/college/eldenburg). medical supplies is a mixed cost.80 D. current illnesses that are circulating in the area. Also.$2. There are many possible reasons that could be listed. and so on.412 1. or there are changes in treatment procedures for certain illnesses. Other expenses appear to increase and decrease with number of patientvisits.100 226 664 $19. and so on. weather. Category Medical staff salaries* Medical supplies used** Administrative salaries Rent Utilities Other expenses Total Expenses Fixed $14.736 + $6.07*patient-visits C. • Treatments and related costs may change as new drugs are available.49 ($3.736 Variable $3.115 219 3. E. July expenses are estimated to be: TC = $19.58 $6. gloves.49 Cost Driver Patient-visits Mixed X 2. such as snake anti-venom. 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. Given the preceding computations and cost summary. each patient requires a certain number of supplies. other facilities may open or close. **Using high-low. to find fixed: $3.07*940 = $25. Use the same method for other expenses. Use March.182 . • Prices of all inputs could change (usually increase). but not proportionately.441. Some supplies. high point of medical supplies cost and patient data. the cost function is: TC = $19.934)/(849 – 778).2-38 Cost Management predict next period’s utilities. variable cost is $3.736 + $6. This analysis suggests that there are some of the other expenses are variable costs and some fixed. There is no one answer to this part. At 940 patient-visits. Therefore. and costs go up as patient-visits increase. affecting the number of visits at this clinic.49*849. must be kept on hand whether or not they are used.wiley. These would be fixed. new equipment is acquired. so this cost is classified as a mixed cost. such as tongue depressors. .

Some costs are discretionary. If enough data points are available. Information about number of employees and hours worked is found in the payroll accounting system. In some ways.g. Vendors. could be used to identify costs for building and occupancy costs. analysis at the account level could be used to develop a cost function using information from the general ledger. Some future costs can be estimated with high accuracy based on prior commitments (e. prepaid insurance schedules. rent). and D. Number of work stations might come from the department head. . Accounting records could be accessed to determine the wage rates and time worked for help support staff and supervisors. with representative points selected from a scatter plot. department heads. depreciation schedules. a personal budget estimation problem is similar to the cost estimation problem for a business. B. Other costs are highly uncertain and subject to external factors that cannot be controlled. The cost object is the help line. number of hours worked. C. It would be useful to obtain several years of monthly data from which to prepare scatter plots and run regression analysis. and other miscellaneous costs. B. cost allocation records could be used to identify past costs. or it might need to be estimated if it has not been tracked in the past. Analysis of general ledger entries could be used to determine past costs for phone service.38 Personal Cost Function A. supplies. This data could be found in the accounting system. a two point method might be best. regression analysis would probably be the best choice. number of employees. Possible cost drivers include number of calls handled. C. D. If not. Regression analysis makes use of all data points and is more accurate than twopoint methods.. The answers to these questions depend on the individual student’s data and cost behavior. Alternatively. Number of calls might have to be tracked by employees or by the telephone system. or total number of Internet customers. If the help line is housed in its own building. E. assuming a linear cost function. number of work stations. Number of customers is part of the revenue accounting records. If the service is housed in a common building. The choice of information sources depends on how the past cost information is to be used. 2. etc.Chapter 2: The Cost Function 2-39 2.37 Cost function Judgment and Method A. and others could be interviewed to identify any potential cost increases or other expected changes in cost behavior from prior periods.

750.800.036 68. July’s result is an outlier and should be removed from the data.150 73. Operations in the month of July are not typical of the rest of the time period.2-40 Cost Management 2.800 . No adjustments are needed for items (c) and (d).83/mo.310 70. these are correctly handled.376 65.200 Apr 71.8 x 6.10.850 2 . A spreadsheet showing the solutions for this problem is available on the Instructor’s web site for the textbook (available at www. the trend line is likely to distort costs. B. as shown in the scatter plot below. 1/2 of August 5 payroll goes to July: 5. 80% of September 2 payroll to August: .wiley. Similarly.800 41. but there is insufficient information to make an adjustment.500 x 1/2 = 2. available on both the Instructor and Student web sites for the textbook (available at www.736 67.686 71.486 68. IP-14 3 Payroll paid every two weeks.200 +$2. If these observations are included in the regression analysis. The miscellaneous supplies account also looks suspicious.750 + 4.39 Smeyer Industries The data for this problem can be found on the datasets file for chapter 2.com/college/eldenburg).236 69.750 .com/college/eldenburg).500 38.750 68.300/10 x 12 = 35. Adjustments to more accurately reflect overhead costs incurred: Unadjusted Overhead Mar $68.596 73.250 May June July Aug Sept Oct Nov 1 Property Tax(a) +$500 + 500 + 500 + 500 -3. A.300 + 36 + 36 + 36 + 36 + 36 + 36 + 36 Other Payroll3 Adjusted Cost $68.2. Because of the large difference between these values and the values in other months.wiley.000 + 500 + 500 + 500 + 500 + 500 Depreciation(b) +$36 1 + 36 -4. (rounded to $36) 2 Note IB-4's power added to Dept.350 68.4.000 = 4.790 80.736 To predict future overhead. . the first month is adjusted even though it is not an actual cost: 4.286 68.

26 3. they are most likely recorded at the time of purchase rather than at the time of use. According to the details provided for August and September.500 8.641981 0.500 5. supplies were a large proportion of overhead cost.000 Overhead Costs $70.47 8 Standard Error 29406. the fixed cost does not appear to be different from zero.500 Outlier Direct Labor Hours C.000 $55.000 9.310484 Intercept X Variable 1 Coefficient s 8777.086126 Based on the t-statistic and p-value for the intercept.000 6.79 * 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).000 2.789722 t Stat 0.775388 0. Based on the variation in dates at which supplies are recorded. Therefore. the cost function is estimated as: Overhead cost = $6.050976 P-value 0.000 $65.000 3.818 6.314163 1980. Here are the regression results: Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations 0. D.Chapter 2: The Cost Function 2-41 Scatter Plot of Adjusted Overhead Costs Against Direct Labor Hours $75.298502 2.000 $50.000 $60.000 $40. Thus. Monthly overhead costs for supplies may be significantly overstated or understated .412139 0. considerable future variation in overhead costs is likely to occur due to factors other than changes in direct labor hours.000 $45.

the accounting records might not accurately reflect the costs incurred during each time period. First. financial statements may be prepared less frequently than data is collected for cost estimation. these variations would need to be considered. If the cost function is for annual costs. For example. In addition. this may not be a problem. power costs could be adjusted upward if utility rates in the future are expected to be higher than in the past.2-42 Cost Management if the amount of supplies inventory varies significantly from month to month. 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. sometimes known changes have occurred in prices or cost behavior. The process of preparing financial statements often includes adjustments so that costs are recorded in the correct time period. adjustments could be made to adjust the balance in supplies inventory each month. Second. Thus. 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. there could be seasonal variation in costs such as overtime pay and utilities. but if the company would like information about predicted monthly costs. E. Additional adjustments include any expected changes in costs from prior periods.

variable or mixed. A measurement is appropriate if it is suitable for the purpose. then simple regression is inappropriate.17 for the pros and cons of each method. relevant. It is often difficult to identify an appropriate. 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. b. Suppose a cost function is measured for the purpose of estimating future costs. for example. Chapter 2 introduced the following measurement methods for estimating a cost function: Engineered estimate of cost. how to categorize costs as fixed. two-point method. and they prevent complete accuracy in making accounting measurements. and multiple regression (Appendix 2A). and how to interpret computational results. sometimes the cost of obtaining a better measure exceeds the benefits. 1. which typically involved creating a cost function for one or more individual costs. which factors drive variable costs. the main focus was on measuring costs for a cost object. it is necessary to use judgment when choosing and applying measurement methods. analysis at the account level. A cost function estimated from past cost data may be unreliable if future operating activities are expected to occur in a different relevant range. See Exhibit 2. 4. . In Chapter 2. 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. For example. B. the best choice of estimation technique. 2. If the cost is believed to be nonlinear. Uncertainties prevent identification of single “correct” measurement methods. It is also necessary to evaluate the quality of measurement results when using accounting information. high-low method.40 Focus on Professional Competency: Measurement A. simple regression. and reliable measure for estimating a cost function because of uncertainties about: data availability. whether past cost behaviors will continue in the future.Chapter 2: The Cost Function 2-43 BUILD YOUR PROFESSIONAL COMPETENCIES 2. Thus. When estimating a cost function: a. A measurement is relevant if the resulting cost function information helps decision makers choose between alternative courses of action. 3. whereas variable costs are often relevant. C. Fixed costs are often irrelevant to decisions. a cost function should distinguish between fixed and variable costs. A measurement is reliable if it if it is reasonably free from error and bias. For example. c.

students might think of others.9). the manager should be informed about key uncertainties or risks associated with using the cost function. Changing circumstances can change the patterns of cost behavior and cause an estimated cost function to be inappropriate. Here are some desirable characteristics of a report about an estimated cost function. then it should probably describe all of the major decisions involved in developing the cost function. However. and/or unreliable. then the details of the estimation process may be irrelevant. If the report will be presented to a superior within the accounting department. then it may be more important to provide the cost function information rapidly than to prepare a high quality report. It is important to present the cost function information objectively to improve its relevance and reliability for the user. • The use of technical language should depend on the audience. However. Note: Some of these ideas were adapted from the Path to Higher-Quality Management Decisions presented in Chapter 1 (Exhibit 1. clear. and easy to understand. • The desired quality of the report should be weighed against the timeliness of information for the user. • The report should focus on information that will be relevant to the user. irrelevant. It is typically appropriate to use more technical language in reports written for other accountants than in reports written for non-accounting audiences. If the report will be used by a manager who needs to estimate future costs. People who lack objectivity are likely to present biased information that impairs high quality decision making.2-44 Cost Management 5. the user should be informed about the priorities used in creating the report. • The format should be concise. If the user needs to make a decision quickly. D. taking into account the knowledge and interests of the user. .

Here are the simple regression results: Regression Statistics Multiple R 0.96 x number of chairs produced However. The cost function is estimated as: Labor cost = $133. A spreadsheet showing the solutions for this problem is available on the Instructor’s web site for the textbook (available at www.437E-24 1.com/college/eldenburg).3147402 P-value 3. using monthly data for the prior 4 years. .wiley.04 13. the prior labor costs are biased downward—future labor costs are expected to be higher than past labor costs. Also. Because of the annual pay increases.7995 Observations 48 Coefficient s 133194.6004687 Adjusted R Square 0.41 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.5917832 Standard Error 6216.02E-10 Based on the regression results. However.678620854 Intercept X Variable 1 t Stat 19. the degree of downward bias is higher for older data than for more recent data. A.609693 1. the cost function was estimated by regressing actual labor costs on number of chairs produced.194 + $13.Chapter 2: The Cost Function 2-45 2.com/college/eldenburg).] The data for this problem can be found on the datasets file for chapter 2. Considerable variation in labor costs is not explained by changes in the volume of production. students are likely to struggle interpreting and choosing a method (Parts E and F).7748991 R Square 0.848277 8. In prior years.957296 Standard Error 6710.wiley. the regression explains only about 59% of the variation in labor costs. available on both the Instructor and Student web sites for the textbook (available at www. B. the fixed cost and the variable cost per unit are each positive and statistically different from zero.

390275 Intercept X Variable 1 t Stat 24. The fixed cost is nearly the same.742261 Standard Error 5148.00872 Intercept X Variable 1 X Variable 2 t Stat 18.54295 Standard Error 5689.533 Dec 20X4 196.93821 16.57E-23 2.05E-27 2.869633 Adjusted R Square 0.73E-20 5. this cost function would result in a higher estimate for future costs.35E-15 Based on the regression results.67711 P-value 1. the fixed cost and the variable cost per unit are each positive and statistically different from zero. here are the regression results: Regression Statistics Multiple R 0.863839 Standard Error 3742.96 to $16.02)4 $196.486389 P-value 4. but the variable cost increased from $13.09577 6.02 Adjusted Labor Cost $220. Here are the multiple regression results: Regression Statistics Multiple R 0. approximately 26% of the variation in labor costs is still unexplained.91E-08 . Also.347 Calculation $203.010513 1.492 1. Nevertheless.533 x (1.8 16.23 per chair.932541 R Square 0.2-46 Cost Management C. Here are a couple of months’ data for double-checking the calculation of adjusted labor costs: Month Original Labor Cost Jan 20X1 $203. D.74).905 Observations 48 Coefficient s 133736 16.06236 11.23 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 0.23439 Standard Error 5557. which is reasonable given the increase in wage rates over time.274 Using the adjusted labor cost data.311 200.864722 R Square 0.411 Observations 48 Coefficient s 107748.747745 Adjusted R Square 0. The cost function is estimated as: Labor cost = $133.736 + $16.891 1.347 x 1.26499 6.

If the prior month’s production was higher than this month’s production. and they both have positive and statistically significant coefficients. each month’s labor costs are expected to increase by $16.54 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. 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. E. the fixed cost and the variable cost per unit for each cost driver are all positive and statistically different from zero. then this month’s labor costs will reflect a lower level of labor cost.54 for each chair produced during the prior month. . and the managers often delay laying off employees when volumes decline. In addition. Conversely. the two cost drivers together explain a very high proportion (86%) of the variation in past labor costs.l6 for each chair produced during the month.749 + $16. each month’s labor costs are expected to increase by $6. it often takes time for the company to hire qualified new workers. As explained in the problem.26 x current month number of chairs produced + $6. On one hand. and this regression explains more of the variation in labor costs (86%). The first slope coefficient ($16. it could be argued that some other cost driver might do a better job of predicting future labor costs. Thus. if the prior month’s production was lower than this month’s production. The second slope coefficient requires more thought. However. F. The cost function is estimated as: Labor cost = $107. According to the multiple regression results. the company’s policy is to increase the number of workers when production volumes increase. and to decrease the number of workers when production volumes decrease. There is no one single answer to this question. then this month’s labor costs will reflect the higher level of labor cost.Chapter 2: The Cost Function 2-47 Based on the regression results.26) is interpreted in a straight-forward way. On the other hand. there may be some lag between the time that production volumes change and labor costs change.

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