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  • 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

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)


Cost Management

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.





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.





Cost Management

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.




TC = $10. For the firm to make this cost direct for the personal returns cost object. The time records that the tax partner maintains support this cost as a direct cost.000 $11. In a service business such as this. and Piecewise Linear Cost Functions A. 2.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.000 $9. Now notice that the tax partner's salary is considered a direct cost for all three cost objects.000 $13.000 + $8. CPAs do keep detailed time records. so a portion of his or her salary is direct only to the tax department and indirect to the two other cost objects. the tax partner probably spends some time in non-billable activities.000 Total Cost $12.00*Q Graph of Cost Function $14.000 $8.000 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 .13 Linear. The benefits of tracking the cost at that level do not exceed the benefits of the information that would be obtained. the CPA's time is the product being sold. the administrative assistant would have to maintain detailed time records as to time spent working on personal returns versus corporate returns.000 $10. Of course. Stepwise Linear.

000 – 10.000 = $60.000 + $8.00*Q.000 $20.000 * $44 = $528.000 $0 0 1.000 TC = $35.000 Total Cost $50.000 Combining the fixed and variable costs to create the cost function: TC = $60.000 = F + $39*10. To estimate the costs at another production level.$390.2-6 Cost Management B.$450.00*Q.000 $40.000 $10.000 $60. TC = $25. for Q ≤ 2.000 Total cost at 12. it is first necessary to estimate the cost function.000 Calculate the variable cost per unit using the Two-Point method: Change in cost Change in volume = ($528.000 Graph of Cost Function $80.000/2.000 $30.000 * $45 = $450.000 4.000 $70.000 Number of Units C. Convert the average costs to total costs for each production level: Total cost at 10.000 + $8.000 3.000) = $78.000 units = 10.000 2.000 .000 units: $450. for Q > 2.000)/(12.000 units = 12.000 .000 = $39 per unit Use one data point in the total cost function and solve for F: Using the data for 10.000 F = $450.000 + $39*Q .

000 $55.000 + $10.00*Q.000 Estimated cost per unit = $645.Chapter 2: The Cost Function Estimated total cost at 15.000 Number of Units Slope is $10 per unit Slope is $9 per unit Total Cost .00*(Q-1.000 in revenues into the cost function.000 0 500 1.000: TC = $50.000 $50.000 1.000 $60.500 2.000 = $43 D.000 $65.000 + $39*15.000 $70.000 * $10.14 Piecewise Linear Cost Function A. for Q < 1. TC = $50.000 TC = $51.000 For Q > 1.500 2.000 + $10.000 $45. Inserting $10.000 = $60.$9.000) TC = $50.000 + (1. total cost is estimated as: TC = $5.000 + 45%*$10.00) + $9.000 = $9.000 = $645.000 + $9.000 units: TC = $60.00*Q .000 + $9.000/15.00*Q 2-7 Graph of Cost Function $75.000 + $585.

2.2-8 Cost Management B. 2. Hours for two returns would be determined as follows.3 and 2A. then the cost function would be some mixture of the functions for the two relevant ranges.00*Q.000 units.8 hours (average time for each of the next two returns) B.15 Tax Plus A.000 units. then the cost function would appear to be: TC = $50. using the learning curve equation Y = α Xr Learning rate = 80% α = 6 hours X (units produced) = 2 Learning rate = (ln 0.000 units but would overestimate total cost for Q > 1. If the data estimation points occurred across the two relevant ranges.00*Q. This cost function would provide reasonable estimates for Q > 1. If the accountant did not detect that there were two different relevant ranges.000 units but would underestimate total cost for Q ≤ 1.000 + $9. If all of the data estimation points occurred when Q was ≤ 1.000 + $10. 3.000 units. then the cost function would appear to be: TC = $51.80/ln2) = −0. There are three general situations: 1.3219 Y = 6 hours*2-0. Graph of Learning Curve Cumulative Average Hours Per Return 7 6 5 4 3 2 1 2 3 4 Cumulative Number of Returns Prepared . If all of the data estimation points occurred when Q was > 1.000 units.3219 Y = 4. the cost function mismeasurement depends on the values of Q. This cost function will either overestimate or underestimate costs for almost any level of Q (see Exhibit 2A. This cost function would provide reasonable estimates for Q ≤ 1.4.

it is a common cost of production for all of the bowls that are heat-treated in the kiln. 2.] A. as their performance improves. it is a direct cost. In addition. I. However. Depreciation on the kilns is indirect because it cannot be directly traced to individual bowls.000/$32. Assuming that the cost of clay can be traced to each bowl. the cost function is: TC = $20. The cost probably does not depend on production volume (assuming depreciation is not based on units produced). D. If total variable costs were $8. if time is not traced to individual bowls (for example. this particular cost function assumes that variable costs are driven by sales. and variable costs remain constant within the relevant range. and their productivity rate will remain stable. or 25% of sales Combining fixed and variable costs. Total clay cost will vary with the number of bowls made. D or I. their productivity increases. then variable cost per dollar of revenue is calculated as follows: $8. F .000 = 0. B. 2.Chapter 2: The Cost Function 2-9 As the accounting graduates become more familiar with the tasks involved in preparing simple tax returns. Note: Depreciation using a method such as declining balance is not constant over time. that is.000 on total sales of $32.000.17 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.16 Bison Sandwiches A. then wages would be an indirect cost. Wages are fixed because they remain constant (the employee always works 40 hours).000 + 25%*Total sales B. but would still be considered fixed because it does not vary with production volume. Assumptions: Fixed costs remain fixed within the relevant range. it improves less quickly for the next return. V C. 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. 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.25. making it a fixed cost. wages are a direct cost. However. Eventually their learning will plateau.

depending on what causes the cost to vary.000 2.18 Yummy Yogurt [Note about problem complexity: Item A is coded as “Extend” because judgment is needed for categorization. I. They might be fixed or variable. H. part of the cost might vary proportionately with volume. depending on whether they are “used up” after a certain quantity of production. V If the glaze is expensive and therefore a relatively large cost. making them a common cost for multiple units and an indirect cost. F I. D or I. If the kiln is electric. Advertising is not directly related to production. V Assuming that the cost of packing materials is traced to each bowl. Also.500 ______ $4. It is mostly likely a flat fee or is calculated on a basis unrelated to production volume. If it is an hourly charge. it might not be traced to individual bowls. F.300 $3. G.500 . F or M Pottery studio maintenance is an indirect and fixed cost if it is the same payment every week. F or M Electricity is an indirect cost because it cannot be traced to individual bowls. making it a fixed cost. making it an indirect cost. then this cost could be indirect. V or F Brushes for the glaze are most likely used for multiple bowls. F The business license is not related to production. If the cost of glaze is very small. I. It might be fixed or mixed. If the packing materials are not traced (for example. D or I. I. Packing costs are most likely variable because they will increase as production increases.2-10 Cost Management D. I. it is most likely traced to individual bowls. it is probably a mixed cost. I. if the cost is too small to justify tracing them). making it an indirect cost. J.000 in sales $1. so it is treated as fixed. Fixed Cost of ingredients Rent Store attendant (salaried) Total Costs at $9. 2. because the production area may need more cleaning as volumes increase. this is a direct cost. making it an indirect cost. E. This cost is also discretionary.] A. if the cost is small it might be grouped with overhead costs (variable). making it a direct and variable cost.300 Variable $4.

total revenue (TR) instead of quantity (Q) can be used in the cost function: Total variable cost/Total revenue = $4. F or M Employee benefits occur in any business in which employees are hired. F. In this type of situation.300 + 50%*Total revenue C. or M There would most likely be hourly wages in both types of businesses (assuming employees are hired). D. or 50% of revenue Combining fixed and variable costs. these costs would be mixed with a large proportion of the cost fixed. Benefit costs often vary with level of wages or salaries. FB. F There would be no reason to incur fishing equipment costs in a pizza business.Chapter 2: The Cost Function 2-11 B. and the cost would vary with number of pizzas produced. Benefits might include mandated items such as social security.50. Some may be sent home if business is very slow. In the fishing boat business. Therefore. The cost of rent is irrelevant because it will not change with either alternative. . V. so they would tend to be fixed or mixed (see Item A above). B. workers’ compensation. B. In the pizza shop. 2. they are more likely related to time on the boat than pounds of fish. because of uncertainty in the success of each fishing expedition. F. B. employees are likely scheduled in advance on a fixed schedule. the cost function is: TC = $3. C.] A. The opportunity cost is the contribution margin from the products sold with the flavor that has been replaced.500/$9.000 = 0. V Ingredients are used in making pizzas. Hourly wages on the fishing boat most likely vary with the number of days or hours the boat is out fishing. costs vary with dollars of revenue. and G are coded as “Extend” because they require substantial business knowledge and/or ability to visualize cost behavior. E. as well as voluntary items such as health insurance and retirement benefits. PS. While hourly wages may be related to number of fish caught. and unemployment insurance.19 Pizza Shop and Fishing Boat [Note about problem complexity: Items C. There most likely would not be any ingredients in a fishing boat business. In many organizations. D. this cost would most likely be fixed because the cost would not vary within a relevant range of activity.

Cheese ($2. F or M Any type of business will have insurance costs. F. Mustard ($.69/7) $0.95/2.20 Hamburger Haven Following are calculations for the cost per unit of each ingredient and the cost of plan and cheeseburgers: Cheeseburger Cost per Unit Plain With Everything 1. If the fishing boat is for tourists. B. Lettuce ($. although the cost would probably be much higher for the pizza business because of the utilities needed to run the pizza shop.000) * 4] 0.0863 0.5195 = $1.$0.29/12) 0.2414 2.0148 6. Catsup ($.6815 .69/8) 0.49/(16 x 4)] 0.0033 0.1619 0.0179 0.15/45) 0.0198 0. there might be some utility costs for the fishing operation and for a business office. Cost of plain burger = $0. the utility costs for these two businesses would tend to be fixed (would not vary with production).3489 (calculated above) B. G.0148 0. F Most pizza shops incur advertising costs such as flyers. newspaper advertisements. Hamburger patty ($1.0233 7.56 .1075 0.3489 $0. The cost might be fixed or mixed. F Some type of utility costs (such as water and electricity) would be incurred in both types of business.1619) = $0. Onions ($.59/40) 0. For the fishing boat business. Because advertising costs tend to be discretionary. Hamburger bun ($1.0863 5.0198 9. Tomato ($. It will be a fixed cost if it is a flat amount.2-12 Cost Management E.1619 10. 2. depending on how the insurance cost is calculated.6815 A. they are treated as fixed costs. PS.1075 3.99/50) 0.59/16) 0. but it might be mixed if a portion of the cost relates to levels of business activity. and yellow pages advertisements.0179 4.5196 Suggested selling price: 300% * $0.79/150) 0.0053 0.0233 0.0053 8. Cost of burger with everything except cheese = ($0.0033 $0.1075 0.2414 $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. In general. Dill pickles [($8. Mayonnaise [$1. advertising costs would be incurred.2414 $0. B.

B. This means that her costs need to be below the competitive price.79 Some students will view this higher price as "unfair. that is.04 . that cost would be variable. Alternatively.] A. if her prices are too low. B.25 = $1.Fixed E. Clerical wages – Fixed unless overtime is regularly scheduled. most organizations are price takers.Fixed and discretionary I. 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. If there is part time help. there is no moral obligation to maintain a 300% markup on each item.Mostly fixed and discretionary H. she foregoes profits and people may believe there could be quality problems with her food. Alternatively. If Ms.04 Therefore.Mixed.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. Professional subscriptions. In the current business environment. they set prices considering their competitors’ prices. However staff are often salaried. the price of the plain hamburger should be: $2. Long’s prices are too high. Long is able to differentiate her hamburgers from others in the market. Property taxes. and then mixed C. and F) are the ones requiring significant assumptions to generate an answer. in which case the total cost would be primarily fixed. FICA taxes (Social Security taxes) – Mixed – mostly fixed because most employee wages would be fixed J. Licenses. D. mostly variable G. volumes will drop because customers will go to other fast food restaurants that sell hamburgers. Rent .Chapter 2: The Cost Function 2-13 C. Therefore. Market forces will dictate achievable prices. 2. she needs to know what competitors charge for a similar quality sandwich and price hers competitively. Professional dues.Fixed F. The Step 2 questions (A. Selling price of cheeseburger with everything: 300% * $0.6815 = $2. Insurance.$0." However. It is just a general guideline. Office supplies . Staff wages – Could be variable or mixed (salary + overtime) for regular staff.Fixed . if Ms.

In this problem. 2. the analyst could ask the CFO whether the marketing department budgets its costs through a negotiation process with top management. The cost analyst needs to gather information about how marketing costs are set each year.com/college/eldenburg).22 Cost Function Using Regression. TC = $222. the variation in units sold explains about 61% of the variation in marketing department cost. Therefore.2-14 Cost Management K.wiley.) B.] The data for this problem can be found on the datasets file for chapter 2. or profits. In addition. A spreadsheet showing the solutions for this problem is available on the Instructor’s web site for the textbook (available at www.wiley. it is possible that marketing costs are discretionary. Advertising – Fixed and discretionary 2. . the cost is discretionary and will be set through the negotiating process. available on both the Instructor and Student web sites for the textbook (available at www. C. Other possible cost drivers for marketing department costs could be revenue. the fixed cost is set at zero.35*units sold. If this is the case. (Notice that the T-statistics on the fixed costs indicate that it is not likely to be different from zero. number of advertisements placed. Other Potential Cost Drivers A. The adjusted R-Square indicates how much of the variation in the marketing department cost can be explained by variation in units sold. For example.com/college/eldenburg).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.

761602 4.Chapter 2: The Cost Function 2-15 A.500 $1.000 $500 $0 0 500 1000 Output 1500 2000 Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations 0.113687834 Intercept Output t Stat 5.58E-05 0.582691 P-value 6.61765897 0.000514 .500 Maintenance Costs $2.58824812 182.119724 15 Coefficient s 884.52099624 Standard Error 153.4342166 0.000 $1. Potential Cost Driver: Output Maintenance Costs Against Output $2.026826 0.78591283 0.

005847 0.717372 P-value 0.291084 2.02569657 Standard Error 261.2-16 Cost Management Potential Cost Driver: Direct Labor Hours Maintenance Costs Against Direct Labor Hours $2.60187065 0.017601 .31319046 235.36224828 0.113464425 Intercept Direct Labor Hours t Stat 3.500 Maintenance Costs $2.457384 3.000 $1.500 $1.210849 15 Coefficient s 861.000 $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 0.7549386 1.

97410583 0.815737 29. . the cost driver does not explain the variation in cost and either it is the wrong driver.357393 15.000 $1. Sometimes a cost that is mostly variable can be identified from a scatter plot.6778973 0. or the cost is mostly fixed.42597461 1.500 $1.Chapter 2: The Cost Function 2-17 Potential Cost Driver: Machine Setups Maintenance Costs Against Machine Set-Ups $2.000 $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. machine setups appears to be the most likely cost driver and direct labor appears to be the least likely cost driver. However. a good cost driver would present a linear or football-shaped positive slope or trend. In a scatter plot.500 Maintenance Costs $2.94495003 66. For example.197755 8. In Part A.94888217 0. the trend line for machine setups looks as if the intercept could be zero or very close to zero. all three potential cost drivers appear to be positively related to maintenance costs. If the observations are widely scattered.910475729 Intercept Machine Setups t Stat 1.96E-10 B.5913391 15 Standard Error 93. This indicates that the cost could be totally variable.5343 P-value 0.

588 0.2-18 Cost Management C.313 0.945. 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. This means that variation in setups explains about 95% of the variation in cost. D.945 Cost Function TC = $884 + $0.025*Direct Labor Hours TC = $29. In the machine setups regression. so it is excluded from the cost function. Changes in many factors such as resource prices. E. the t-statistic is significant for the independent variable but not for the intercept. .68* Machine Setups The machine setups intercept coefficient is not significant. The regression using machine setups has the highest adjusted R-Square of 0. the economic environment. business processes.521*Output TC = $861 +$3. and technology can cause future costs to be different than estimated. R-Square 0. This provides confidence that the variable cost part of the cost function is not zero. but does not provide confidence that the intercept (fixed cost) part of the cost function is different from zero. The regression results and cost function for the three potential cost drivers are: Potential Cost Driver Output Direct labor hours Machine setups Adj. Therefore. the cost is likely to be totally variable.

000 = 0. which could be outliers. the cost function is calculated using the highest and lowest values of the cost driver.Chapter 2: The Cost Function 2-19 PROBLEMS 2. on average.333 = F + 5%*$1. or 5% of sales The fixed cost is determined by substituting the variable cost into one of the high-low data points: $68.100 F = $68. The high low method uses the most extreme cost driver values.100 – $632.333 . Therefore.728 Thus. this cost function might provide poor estimates of future costs.$56. First.605 = $11.333)/($1. Under the high-low method.132. the total cost function is: TC = $11.05.728 + 5%*Sales B. not represent the cost most of the time. . Total revenue (TR) instead of quantity (Q) in the cost function because sales is a potential cost driver.000/$500. That means that the cost function might not represent the actual cost. the variable cost is calculated: ($68.132.100) = $25. that is.24 Big Jack Burgers A.333 – $43.

fixed costs are likely to be zero and would be excluded from the cost function. There is a general downward slope (variable cost) that appears to meet the intercept enough above zero to suggest a fixed cost. but the p-value is greater than 10% at 0.172. the cost function would be: TC = 4. trend line extended to Y-axis (dashed line) using Word: Scatter Plot With Trend Line $80. Then.000 $0 $0 $300. Chart of data with trend line added by Excel. Additional judgment is required to decide whether it is appropriate to include a fixed cost in the cost function.000 $600. Because this regression has few observations. In that case. analysis at the account level might indicate that there are few fixed costs. etc). the p-value result for the tstatistic is atypical. Following is the regression output.5% x sales . Analysis at the account level can be used to increase the understanding of this cost. The upward slope of the line indicates that there are variable costs. Alternatively. there is a 16% probability that the intercept (fixed cost) is not different from zero.000 $40.000 Sales It appears that the cost is most likely mixed. If this cost pool includes items such as salaries and other fixed costs (insurance. Notice that the t-statistic for the intercept coefficient is 2.5% x sales. Based on the p-value.2-20 Cost Management C.200.162.000 $900.000 $1.000 Administrative Costs $60. the regression intercept can be used as an estimate of the fixed costs. D.800 + 4. Then.000 $20. the cost function would be TC = $16. A t-statistic greater than 2 is often interpreted as meaning that the coefficient is significantly different from zero.

the results rely on more complete information and provide a better estimate.2444 7734. Sales does not appear to explain much of the variation in research and development costs. The plot shows costs that are widely scattered.9680477 0.90567454 3293. especially because so few observations were used in the estimation.17205158 5. The adjusted R-Square statistic is very low at 0.82%*Sales C. the cost function is: TC = $50. the high-low method may be the best option available. If there are more data points. and it can be further improved by adopting more representative data points than the highest and lowest values of the cost driver. There might be a large discretionary component in administrative costs. and possible changes in costs such as those described in Part E are ignored.45937486 P-value 0.93711636 0. Future costs are not likely to be estimated accurately if the cost driver explains only a small part of the variation in the cost. The cons of the high-low method as an estimation technique were discussed in Part B above. This method can be used in cases where there is not enough data to perform regression. Because of unforeseen changes in cost behavior.25 Scatter Plot. If there are only two or three data points. both of these methods assume that the data points are representative of future costs.186.04466925 0. there does appear to be a general upward trend. on average.16197623 0. B. Both methods assume that the cost function is linear and that all data points come from a single relevant range. Unusual cost items are assumed to continue in the future.73545 0. then both methods may be unsuitable for estimating future costs. If these assumptions do not hold. a cost function may not provide a good estimate for the next month’s costs. however.00818212 t Stat 2. However. There might be a change in business operations or in the economy that would cause future costs to be different than in the past. . In addition. Therefore. regression analysis incorporates all of the observations into the analysis. 2.4038 4 Coefficients Standard Error 16800. The past costs used for estimation might not be representative.365 + 0.0319523 Intercept X Variable 1 E. Sales might not be the activity that drives administrative costs. Using the regression results. causing fluctuations in cost that are unrelated to any cost driver.Chapter 2: The Cost Function 2-21 Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations 0. F. Cost Function Using Regression A. This means that variation in sales explains only about 18% of the variation in research and development cost.

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

students may think of others.00 + (700-500)*$0. Here are some of the reasons.Chapter 2: The Cost Function 2-23 consulting jobs.1 hours (average time for the first four batches) B. If her calls are over 400 minutes or under 600 minutes.10 = $30. In . 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. 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.04 $0. I.00 + (600-500)*$0.90/ln2) = −0. Minutes 300 400 500 600 700 Total Cost $20. which appears to be the other alternative (although the 5 cents per minute rate might not be available for daytime week day calls).05 $0. she will pay a very high rate of 10 cents per minute 2. There are many different reasons that the time could be different from the amount determined above. her phone bill will be less than it would be at a rate 5 cents per minute.or overestimated the amount of hand work performed. telephone costs are viewed as an indirect cost.05 $0. It is possible that the managers under. Hours per batch would be determined as follows.27 Fancy Furniture A.152 Y = 10 hours*4-0.10 = $40. In most businesses. so Susan may need to maintain her own records if she wishes to trace telephone usage.067 $0. Many cellular telephone bills do not list the calls made. Cons • If Susan has a number of projects in her local area or will be traveling a lot.00 $20.00 $20.057 The average cost is lowest at exactly 500 minutes per month. 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 $20.00 Average Cost $0.152 Y = 8.00 $20. 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.

500 10. if managers believe that more than 25% of the work is done by hand.000 Profit = Revenues – Total costs = $80. If these values are used in a regression to estimate a cost function. D. If a worker is absent one day. and the University surcharge is specifically based on sales.000 5.2-24 Cost Management addition. or has a great deal of experience on the machine.000 = 0. if managers believe that 25% of the work is done by hand.000 . Because revenue is the cost driver for both variable costs. C.000 Total revenue is the most likely cost driver for both variable costs. Food costs are likely to vary proportionately with sales.000 .$79. it is possible that different types of wood affect the rate at which chairs can be produced. or 40% or revenue Combining fixed and variable costs. However.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 1. The estimate of total costs given revenues of $80. C.500 $47. 2. total revenue (TR) instead of quantity (Q) can be used in the cost function: Variable cost = $28.000 = $1.000 _______ $28. The observations of labor costs over the first few weeks would not be representative of the labor costs once productivity has stabilized. Thus.000 7.000 Variable $21.40.28 Wildcat Lair A.000 + 40%*80. and B.000/$70. Wildcat Lair costs: Purchases of prepared food Serving personnel Cashier Administration University surcharge Utilities Totals Fixed $ 30. the cost function is: TC = $47. then the chart suggests that the learning rate estimate is reasonable. the rate will change if the replacement employee has never worked on this machine.000 = $79.000 + 40%*Total revenue D. then this chart suggests that the learning curve will be slower than the 90% estimate. they would be higher than the labor costs in later periods. then the cost would be overestimated.

B. Variable food costs are estimated to be 30% ($21.000 ($10. the additional profit from a $10.000) Net 2. the shop might experience very little business activity.000+$6.000 increase in revenues is expected to be $6.000) of revenues. To estimate the opportunity cost for August. Only total variable costs are expected to increase.000 (47. Lair’s fixed costs are assumed to be unchanged with the $10.000)+the university surcharge of $7.000/$70.000) (24. F. electricity usually varies with hours of operation and possibly with the season (because of heating and air conditioning). So. The shop is most likely a seasonal business.000) $ 9. but this is not considered a cost driver (a business activity that causes variations in total variable cost). 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).000— the operating loss of $(5.000 (-$5. less the fixed costs and the variable food costs. Electricity costs also vary with changes in electricity rates. In a retail business. if the bathing suit shop is located in a geographic region $80. So. If the university were to close the Lair.000 .Chapter 2: The Cost Function 2-25 E.000 ($10.) The adjusted cost function is: TC = $47. A shop located near a ski area is likely to incur high heating costs during the winter.] A.000 . (This is the same as the previous 40% variable cost rate less the university surcharge of 10% of revenues.$4.29 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). generating most its sales around the ski season (fall and winter). it would lose the revenues.000). C. the opportunity cost is estimated to be: Revenue Fixed costs Variable costs (30%*$80.000*40%). Assuming the highest electricity cost is during the winter when fewest bathing suits are sold. for July the opportunity cost would have been $2. so the trend would be the opposite of this plot. Thus. so the estimated profit in August is $1. costs would be higher when there were fewer sales. and the increase is estimated to be 40% of the increase in revenues. total variable costs are expected to increase by $4.000 increase in revenues.000.000 + 30%*Total revenue During August. However. During the spring and summer months.000. Because the university surcharge is an allocation within the university. it might even close when the ski area shuts down. In July there was a loss of $5. the variable cost part of the cost function can be adjusted. Item D will be VERY difficult for most students.

given a 100 unit production level: Y = α Xr Y = $300*100-0.67 Firm A's income for last year was: Sales Costs Income $1.30 Firm A and Firm B Costs for Firm A in the first year would be determined as follows.85/ln2) = 0. then the highest sales might coincide with the highest electricity costs. 2. special promotions.22 Firm B set its selling price based on the average cost.45 $ 514. generally mean there is more money available to spend on administrative travel. D. However. correlation does not necessarily mean causation.67 1. A correlation may appear in a scatter plot or regression analysis.45 x 1.69 x 5 = $1. For example.2345 Y = $205. using the learning curve equation Y = α Xr α = $300 instead of hours X (units produced) = 5 Learning rate = (ln 0. Higher profits.028.2-26 Cost Management where the highest electricity costs occur during the summer because of air conditioning.89 (average cost for each of the 100 units produced) Given a 50% markup on cost.028. employee training. and new office furniture or equipment.5 = $152.89 x 1. higher profits generally occur during periods when activity is high.542.028. Many costs can be related to volume of activity. in turn. firm B's selling price is: $101.84 .69 (average cost for each of the 5 units) Total cost = $205.45 Although each customer paid a different price. they are discretionary expenditures and not caused by the level of activity. a 50% markup on total cost will cause sales to be: $1.542.50 = $1.2345 Y = $300*5-0.2345 Y = $101. Although these expenditures are made because more money is available.

2345 Y= $78.40 Firm A's costs may be computed as follows: Y = $300*15-0.10 $ 172.85 x 1.75) 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 = $9.84) Costs (150 x $ 92.625.55 1.028.Chapter 2: The Cost Function 2-27 Firm B's costs.00 13.84) = $1.2345 (notice that the cumulative units produced is 15) Y = $158.40 1.926.384.30 $2.356.10 $22.2345 Y = $92.75 (average cost for each of the 300 units) Note that the cumulative production for Firm B through this year is 300 units.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 $1.897. assuming an 85% learning effect would be: Y = $300*150-0.50 $ 9.50/150 units = $64.50 Firm B's calculation for its selling price is as follows: Y = $300*300-0.45 $1.28 $23.85 Thus Firm B's selling price this year was $64.65) Income Firm A's revenues for this year are: (10 x $152.727.50 = $97.00 13.897.028.97 (average cost for each of the 15 units produced) Total cost to produce the first 15 units (15 x $158.528.356.50 .727.50 $ 9.65 (average cost for each of the 150 units produced) Firm B's income statement for last year was: Sales (150 x $152. Total cumulative production cost (300 x $78.

592.28 is lower than Firm A's average cost per unit: $1.000 Marketing Dept. and most of the observations appear to have a fairly linear trend.000 $6.31 Belford’s The data for this problem can be found on the datasets file for chapter 2.50 $ 4.00 9.500. .wiley.28) Costs (150 x $64.000 $8. A spreadsheet showing the solutions for this problem is available on the Instructor’s web site for the textbook (available at www.com/college/eldenburg). Sales seems to be a potential cost driver because there appears to be a positive correlation between the marketing department costs and sales.61.000 Sales B. 2.50 Note that Firm B's selling price for this year of $97. There is a positive slope.000 $135.000 $7. available on both the Instructor and Student web sites for the textbook (available at www.85) Income $14.356.2-28 Cost Management Firm B's income statement for this year is Sales (150 x $97.500.wiley.864.000 $155. Costs $165.000 $145.727. A.500.000 $5. Such results often lead to charges of "unfair dumping" but with large differences in cumulative production volumes.com/college/eldenburg). such extreme differences in cost can occur.10/10 = $135. Scatter Plot of Marketing Costs Against Sales $175.500.

Regression Statistics Multiple R 0. usually annually. Discretionary costs are set by decision.4501E-10 5.2608 0. it is economically plausible for sales to be a cost driver. they may be positively correlated with sales.87116829 Adjusted R Square 0.93336396 R Square 0. If the variable portion of the marketing cost is sales commissions.08144 Observations 30 Coefficients 65584.584 + 1. Assuming that profits are more likely to increase when sales increase.5289E-14 Intercept X Variable 1 Based on the regression results. there would be a positive correlation between marketing department costs and sales.00097028 t Stat 9.63816 0. E. the decision maker(s) should be asked what next year’s cost will be. . Here is the regression output. Therefore. the cost function is: TC = $65. the cost estimate should not be based on past costs. sales may go up.34%*Sales D. F.Chapter 2: The Cost Function 2-29 C. discretionary costs such as marketing are often increased when profits increase. Instead.58184484 13. Even if marketing department costs are discretionary.01335108 Standard Error 6844. In addition. using regression or any other technique.86656716 Standard Error 4015.7600071 P-value 2. When more money is spent on marketing.

000 $40.000 $120.2-30 Cost Management 2.000 $160.000 $120.000 $0 0 500 1000 1500 2000 2500 Labor Hours Manufacturing Overhead Against Machine Hours Manufacturing Overhead Cost $200.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.000 $160. Manufacturing Overhead Against Labor Hours Manufacturing Overhead Cost $200.wiley.000 $0 0 300 600 900 1200 1500 Machine Hours .000 $40.000 $80.32 Peer Jets International The data for this problem can be found on the datasets file for chapter 2.wiley.com/college/eldenburg). available on both the Instructor and Student web sites for the textbook (available at www. A.

D.600712 P-value 6.50852 7.552864 .000 $120.86E-11 0.000 $160. C. None of the plots show a definite trend.682 4.000 $0 0 100 200 300 400 500 600 700 Raw Materials B.000 $40. Costs and potential cost driver data are plotted to determine whether further analysis is necessary. If the observations are widely scattered.11279932 R Square 0. Sometimes a cost that is mostly variable. Labor Hours Regression: Regression Statistics Multiple R 0.000 $80. either the driver is wrong or the cost is mostly fixed.Chapter 2: The Cost Function 2-31 Manufacturing Overhead Against Raw Materials Manufacturing Overhead Cost $200.8173 Observations Coefficient s 150410.01272369 Adjusted R Square -0. Analysis of the plots involves looking for a linear or football-shaped positive slope or trend. The plots help determine whether regression analysis should be performed using any of the potential drivers.02253618 Standard Error 11114. labor hours could be deleted as a potential cost driver. but the plot for labor hours appears to have the least trend. the cost driver does not explain the variation in cost.600936029 Intercept Labor Hours t Stat 10.56597156 30 Standard Error 14812.1543 0. Based only on the cost plots.

67 38. so the cost function is estimated as: TC = $126.217192 Standard Error 10291.5033241 R Square 0. so the cost function is estimated as: TC = $117.2266685 Standard Error 9665.2533351 Adjusted R Square 0.082222 P-value 3. so the cost function is estimated as: TC = $150.91 60.2-32 Cost Management Only the intercept term is significantly different from zero.331580777 Intercept Machine Hours t Stat 11.62907 3.217 + $60.3746211 Adjusted R Square 0.004579 Both the intercept and slope coefficients are significant.22* Raw materials .612063 R Square 0.000325 Both the intercept and slope coefficients are significant.215128 Standard Error 10853.11E-12 0.3522862 Standard Error 8846.095468 P-value 4.53627459 Intercept Raw Materials t Stat 11.68E-12 0.1555 Observations 30 Coefficient s 117598.9786 Observations 30 Coefficient s 126216.4268 4.411 Machine Hours Regression: Regression Statistics Multiple R 0.47803 9.599 + $38.56778 19.22*Machine hours Raw Materials Regression: Regression Statistics Multiple R 0.

3E-06 0.5558 Observations 30 Coefficient s 60988.953575 1. machine hours appears to do the best job of explaining manufacturing overhead costs.2349 3. Multiple regression with all three potential cost drivers: Regression Statistics Multiple R 0.wiley.33 Peer Jets International (continued) The data for this problem can be found on the datasets file for chapter 2.1959303 48.10654585 Intercept Labor Hours Machine Hours Raw Materials t Stat 5.wiley. and the adjusted R-Squares from the regressions are: Machine Hours Raw Materials 0. The coefficients for each of the other potential cost drivers are significantly different from zero.489 -0.352 0.8067018 Standard Error 4832.778501 82.com/college/eldenburg). Labor hours can be eliminated as a potential driver because its coefficient is not significantly different from zero (see Part D). however. Yes.333162437 5. F.226 Based on the simple regression results. the direct labor hours was not significantly related to manufacturing overhead costs using simple regression.886218 -0.08E-08 .12E-09 1.976635 Standard Error 10361.05878 9. A. A spreadsheet showing the solutions for this problem is available on the Instructor’s web site for the textbook (available at www.com/college/eldenburg).8266982 Adjusted R Square 0.291558412 10.210187 P-value 3.218173 8. available on both the Instructor and Student web sites for the textbook (available at www.Chapter 2: The Cost Function 2-33 E. this driver explains only 35% of the variation in cost.9092294 R Square 0. 2.

Costs for these activities are likely related to specific cost drivers. its coefficient is not significantly different from zero in either regression.5348 Observations Coefficient s 60677.226 0. labor hours can be eliminated as a potential cost driver.022 0.74*Machine hours + $82. Each task includes different activities.678 + $48.81383627 Standard Error 4742.55) $38.001) $126.226) for these two cost drivers. C.20 (0.217 (<0.352 and 0. Multiple regression using machine hours and raw materials as cost drivers: Regression Statistics Multiple R 0.001) $60. Both machine hours and raw materials are positive and significantly different from zero when using simple regression and also when using multiple regression.71E-10 5.22 (<0. A combination of cost drivers does a much better job of explaining the variation in manufacturing overhead costs than either cost driver alone.90921678 R Square 0.806) than in either of the simple regressions (0. In this example. Manufacturing can be a complex activity requiring a number of different tasks.86E-07 4.939606 9.925842 30 Standard Error 8743. machine hours and raw materials explain different activity .001) B.157604083 9.2-34 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.954) $48.82667515 Adjusted R Square 0.411 (<0.78 (<0.881964042 Intercept Machine Hours Raw Materials t Stat 6.664851 5. Labor hours does not appear to be a cost driver when using either simple regression or multiple regression.001) $-0. The adjusted RSquare is far higher in the multiple regression (0.988 (<0. Also.352 0.599 (<0.391636 P-value 1.005) $82.22 (0.001) $117.5902 48.57 (0.98 (<0.7422519 82.806 $150.29E-09 The cost function is: TC = $60.450561 8.001) $60.93*Raw materials D. Thus. R2 Simple Regressions: Labor Hours Machine Hours Raw Materials Multiple Regression 0.001) $4.

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

com/college/eldenburg). .000 $15. I would eliminate number of students because there does not seem to be a positive linear relationship between maintenance cost and number of students.000 $5. A.000 $10.000 $0 50 100 150 200 250 300 350 Maintenance Hours Worked Scatter Plot of Maintenance Costs Against Number of Students Maint. available on both the Instructor and Student web sites for the textbook (available at www.35 Brush Prairie High School The data for this problem can be found on the datasets file for chapter 2. or number of classes and activities per period. Dept. square feet cleaned.wiley. Other cost drivers for total maintenance cost could be number of rooms cleaned.com/college/eldenburg). Scatter Plot of Maintenance Costs Against Number of Maintenance Hours Worked Maint. A spreadsheet showing the solutions for this problem is available on the Instructor’s web site for the textbook (available at www.wiley.000 $0 528 530 532 534 536 538 540 542 Number of Students C.000 $5.000 $20. Students may have thought of other drivers that could be logically related to cleaning maintenance costs.2-36 Cost Management 2. number of hours the building is open. Costs $25. number of hours students attend school.000 $15. B.000 $10.000 $20. Dept. Costs $25.

03271 Standard Error 3019.135 + $35.438328 According to the R Square statistics.796328319 Intercept X Variable 1 Coefficients 9134.508157 0. Therefore.0857 Intercept X Variable 1 t Stat -0. 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. changes in maintenance hours worked explains more than 80% of the changes in maintenance cost while number of students explains none. An unidentified cost driver could have a higher R-Square.63E-06 2. From the analyses performed.Chapter 2: The Cost Function 2-37 D. it is considered fixed. 2. The p-values on the Tstatistics are very small.920565237 R Square 0.18E-05 Regression output for maintenance cost and number of students: Regression Statistics Multiple R 0.74733262 t Stat 9. providing high confidence that both the intercept and slope are different from zero. However.68624 0. E.74*maintenance hours worked. maintenance hours is a reasonable cost driver.247329 R Square 0. The total cost function is: TC = $9.06772 Observations 12 Standard Error 965.832184392 Standard Error 1217.36 The Elder Clinic A and B Salaries are always fixed.875134 35.5045837 4.9 244.061172 Adjusted R Square -0.847440356 Adjusted R Square 0. it is logical to expect a strong relation between hours worked and cost. The most current value is used to .453062 P-value 2.173 Observations 12 Coefficient s -89867 197.807201 P-value 0. Regression results for maintenance cost and number of maintenance hours worked: Regression Statistics Multiple R 0. and rent for this type of facility is usually fixed.0261 Standard Error 130954. Utilities cost varies with season not visits. it is rational to conclude that hours worked will provide a reasonable estimate of future costs.461245 7.

variable cost is $3.58 $6. July expenses are estimated to be: TC = $19. Medical supplies vary with number of patient-visits.49*849. Use the same method for other expenses. Also. Some supplies. This analysis suggests that there are some of the other expenses are variable costs and some fixed. the cost function is: TC = $19.80 D. E. Given the preceding computations and cost summary.736 + $6.736 Variable $3. . high point of medical supplies cost and patient data.934)/(849 – 778).wiley.$2. such as snake anti-venom. Therefore. Category Medical staff salaries* Medical supplies used** Administrative salaries Rent Utilities Other expenses Total Expenses Fixed $14.07*patient-visits C. weather. These would be fixed.412 1. Visits are affected by season. There is no one answer to this part. each patient requires a certain number of supplies. so this cost is classified as a mixed cost. There are many possible reasons that could be listed. or there are changes in treatment procedures for certain illnesses. new equipment is acquired. but not proportionately. Use March. and so on. affecting the number of visits at this clinic. • Prices of all inputs could change (usually increase).182 .2-38 Cost Management predict next period’s utilities.com/college/eldenburg).49 ($3.100 226 664 $19.07 Patient-visits X * The value in June is used for fixed costs because the increase in salaries will hold into the future. gloves.441. and costs go up as patient-visits increase. These would be variable.182 = F + $3. such as tongue depressors. Here are some of the reasons: • The managers will not know how many visits they will receive. • Treatments and related costs may change as new drugs are available. to find fixed: $3. must be kept on hand whether or not they are used.07*940 = $25. and so on. 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. medical supplies is a mixed cost. current illnesses that are circulating in the area.736 + $6.49 Cost Driver Patient-visits Mixed X 2.115 219 3. Other expenses appear to increase and decrease with number of patientvisits. other facilities may open or close. At 940 patient-visits. **Using high-low.

. and others could be interviewed to identify any potential cost increases or other expected changes in cost behavior from prior periods. depreciation schedules. C. Analysis of general ledger entries could be used to determine past costs for phone service. In some ways.38 Personal Cost Function A. Some costs are discretionary. a two point method might be best. If enough data points are available. The choice of information sources depends on how the past cost information is to be used. It would be useful to obtain several years of monthly data from which to prepare scatter plots and run regression analysis. rent). 2. Vendors. department heads. E. The cost object is the help line. Possible cost drivers include number of calls handled. or total number of Internet customers. number of hours worked. with representative points selected from a scatter plot. and D. The answers to these questions depend on the individual student’s data and cost behavior. . number of employees. assuming a linear cost function. or it might need to be estimated if it has not been tracked in the past. cost allocation records could be used to identify past costs. etc.g. could be used to identify costs for building and occupancy costs. Number of calls might have to be tracked by employees or by the telephone system. C. supplies. D. prepaid insurance schedules. Other costs are highly uncertain and subject to external factors that cannot be controlled. regression analysis would probably be the best choice.37 Cost function Judgment and Method A. Number of customers is part of the revenue accounting records. number of work stations. a personal budget estimation problem is similar to the cost estimation problem for a business. B. If the help line is housed in its own building. Alternatively. Accounting records could be accessed to determine the wage rates and time worked for help support staff and supervisors. Number of work stations might come from the department head. If the service is housed in a common building. Some future costs can be estimated with high accuracy based on prior commitments (e. Regression analysis makes use of all data points and is more accurate than twopoint methods. If not.Chapter 2: The Cost Function 2-39 2. analysis at the account level could be used to develop a cost function using information from the general ledger. Information about number of employees and hours worked is found in the payroll accounting system. B. This data could be found in the accounting system. and other miscellaneous costs.

350 68.736 67.500 x 1/2 = 2. (rounded to $36) 2 Note IB-4's power added to Dept.000 = 4.750.800.200 +$2.750 68.83/mo.wiley.736 To predict future overhead.500 38.com/college/eldenburg). Operations in the month of July are not typical of the rest of the time period.8 x 6. Similarly. but there is insufficient information to make an adjustment. the first month is adjusted even though it is not an actual cost: 4. available on both the Instructor and Student web sites for the textbook (available at www.39 Smeyer Industries The data for this problem can be found on the datasets file for chapter 2. 1/2 of August 5 payroll goes to July: 5.376 65.4.750 + 4.286 68. No adjustments are needed for items (c) and (d). B. IP-14 3 Payroll paid every two weeks.2-40 Cost Management 2.150 73.686 71.10.310 70.850 2 . Adjustments to more accurately reflect overhead costs incurred: Unadjusted Overhead Mar $68. .200 Apr 71. July’s result is an outlier and should be removed from the data.596 73.250 May June July Aug Sept Oct Nov 1 Property Tax(a) +$500 + 500 + 500 + 500 -3.2. The miscellaneous supplies account also looks suspicious.790 80. A.036 68.750 .486 68. as shown in the scatter plot below.com/college/eldenburg). 80% of September 2 payroll to August: .300 + 36 + 36 + 36 + 36 + 36 + 36 + 36 Other Payroll3 Adjusted Cost $68.wiley.300/10 x 12 = 35. A spreadsheet showing the solutions for this problem is available on the Instructor’s web site for the textbook (available at www.800 . If these observations are included in the regression analysis.800 41. the trend line is likely to distort costs.236 69. these are correctly handled.000 + 500 + 500 + 500 + 500 + 500 Depreciation(b) +$36 1 + 36 -4. Because of the large difference between these values and the values in other months.

500 8.000 2.000 6.000 3.086126 Based on the t-statistic and p-value for the intercept. supplies were a large proportion of overhead cost. the cost function is estimated as: Overhead cost = $6.298502 2. they are most likely recorded at the time of purchase rather than at the time of use.47 8 Standard Error 29406.314163 1980.412139 0.641981 0. Monthly overhead costs for supplies may be significantly overstated or understated . Here are the regression results: Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations 0.000 $45. Thus. the fixed cost does not appear to be different from zero.310484 Intercept X Variable 1 Coefficient s 8777.000 Overhead Costs $70.789722 t Stat 0. Therefore.500 Outlier Direct Labor Hours C.818 6.000 $40.000 $60.26 3.000 $55.000 $65.Chapter 2: The Cost Function 2-41 Scatter Plot of Adjusted Overhead Costs Against Direct Labor Hours $75. D. considerable future variation in overhead costs is likely to occur due to factors other than changes in direct labor hours.050976 P-value 0.000 9. Based on the variation in dates at which supplies are recorded.000 $50. According to the details provided for August and September.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).500 5.

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

Chapter 2: The Cost Function 2-43 BUILD YOUR PROFESSIONAL COMPETENCIES 2.17 for the pros and cons of each method.40 Focus on Professional Competency: Measurement A. In Chapter 2. variable or mixed. high-low method. for example. 4. two-point method. analysis at the account level. Suppose a cost function is measured for the purpose of estimating future costs. a cost function should distinguish between fixed and variable costs. C. Thus. sometimes the cost of obtaining a better measure exceeds the benefits. relevant. If the cost is believed to be nonlinear. Uncertainties prevent identification of single “correct” measurement methods. whether past cost behaviors will continue in the future. For example. then simple regression is inappropriate. A measurement is appropriate if it is suitable for the purpose. A measurement is reliable if it if it is reasonably free from error and bias. B. in Chapter 2 pointed out that a cost function is estimated within a relevant range of activity. See Exhibit 2. and how to interpret computational results. the best choice of estimation technique. The costs and benefits of alternative measures should also be considered. which factors drive variable costs. and reliable measure for estimating a cost function because of uncertainties about: data availability. whereas variable costs are often relevant. how to categorize costs as fixed. 2. b. 1. A measurement is relevant if the resulting cost function information helps decision makers choose between alternative courses of action. the main focus was on measuring costs for a cost object. For example. When estimating a cost function: a. Fixed costs are often irrelevant to decisions. 3. 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. Chapter 2 introduced the following measurement methods for estimating a cost function: Engineered estimate of cost. . which typically involved creating a cost function for one or more individual costs. it is necessary to use judgment when choosing and applying measurement methods. It is often difficult to identify an appropriate. A cost function estimated from past cost data may be unreliable if future operating activities are expected to occur in a different relevant range. and they prevent complete accuracy in making accounting measurements. It is also necessary to evaluate the quality of measurement results when using accounting information. and multiple regression (Appendix 2A). c. simple regression.

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

04 13. the cost function was estimated by regressing actual labor costs on number of chairs produced. the fixed cost and the variable cost per unit are each positive and statistically different from zero.Chapter 2: The Cost Function 2-45 2.wiley. Considerable variation in labor costs is not explained by changes in the volume of production. the degree of downward bias is higher for older data than for more recent data.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. students are likely to struggle interpreting and choosing a method (Parts E and F).com/college/eldenburg).678620854 Intercept X Variable 1 t Stat 19.com/college/eldenburg). Here are the simple regression results: Regression Statistics Multiple R 0. A spreadsheet showing the solutions for this problem is available on the Instructor’s web site for the textbook (available at www.848277 8. the prior labor costs are biased downward—future labor costs are expected to be higher than past labor costs.3147402 P-value 3. . the regression explains only about 59% of the variation in labor costs. The cost function is estimated as: Labor cost = $133. available on both the Instructor and Student web sites for the textbook (available at www. A.7995 Observations 48 Coefficient s 133194.5917832 Standard Error 6216. B. Because of the annual pay increases.7748991 R Square 0. Also.96 x number of chairs produced However.194 + $13.] The data for this problem can be found on the datasets file for chapter 2.609693 1. In prior years.6004687 Adjusted R Square 0. using monthly data for the prior 4 years. However.437E-24 1.wiley.02E-10 Based on the regression results.957296 Standard Error 6710.

905 Observations 48 Coefficient s 133736 16. Here are a couple of months’ data for double-checking the calculation of adjusted labor costs: Month Original Labor Cost Jan 20X1 $203.00872 Intercept X Variable 1 X Variable 2 t Stat 18.23 per chair.23439 Standard Error 5557. approximately 26% of the variation in labor costs is still unexplained.390275 Intercept X Variable 1 t Stat 24. here are the regression results: Regression Statistics Multiple R 0.8 16.02)4 $196.54295 Standard Error 5689.736 + $16.91E-08 .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 0.73E-20 5. but the variable cost increased from $13.891 1.02 Adjusted Labor Cost $220.742261 Standard Error 5148. which is reasonable given the increase in wage rates over time. the fixed cost and the variable cost per unit are each positive and statistically different from zero.533 x (1.869633 Adjusted R Square 0. The fixed cost is nearly the same.747745 Adjusted R Square 0.533 Dec 20X4 196. Here are the multiple regression results: Regression Statistics Multiple R 0.864722 R Square 0.010513 1.2-46 Cost Management C.06236 11.67711 P-value 1.932541 R Square 0.311 200. D. The cost function is estimated as: Labor cost = $133.05E-27 2. this cost function would result in a higher estimate for future costs.35E-15 Based on the regression results.863839 Standard Error 3742.274 Using the adjusted labor cost data.486389 P-value 4.411 Observations 48 Coefficient s 107748.347 x 1. Also.74).57E-23 2.93821 16.96 to $16.492 1. Nevertheless.26499 6.347 Calculation $203.09577 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. On one hand. F.26) is interpreted in a straight-forward way. it often takes time for the company to hire qualified new workers. each month’s labor costs are expected to increase by $16. E. . then this month’s labor costs will reflect a lower level of labor cost.26 x current month number of chairs produced + $6. the company’s policy is to increase the number of workers when production volumes increase.54 for each chair produced during the prior month. As explained in the problem. If the prior month’s production was higher than this month’s production. and they both have positive and statistically significant coefficients.l6 for each chair produced during the month. The cost function is estimated as: Labor cost = $107. then this month’s labor costs will reflect the higher level of labor cost. On the other hand. there may be some lag between the time that production volumes change and labor costs change. In addition. and to decrease the number of workers when production volumes decrease. and the managers often delay laying off employees when volumes decline. According to the multiple regression results. the two cost drivers together explain a very high proportion (86%) of the variation in past labor costs.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 could be argued that some other cost driver might do a better job of predicting future labor costs.Chapter 2: The Cost Function 2-47 Based on the regression results. There is no one single answer to this question. The first slope coefficient ($16. and this regression explains more of the variation in labor costs (86%). the fixed cost and the variable cost per unit for each cost driver are all positive and statistically different from zero. each month’s labor costs are expected to increase by $6.749 + $16. Thus. However. if the prior month’s production was lower than this month’s production. Conversely. The second slope coefficient requires more thought.

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