Tessmer Manufacturing Company produces inventory in a highly automated assembly plant in

Olathe, Kansas. The automated system is in its first year of operation and management is still
unsure of the best way to estimate the overhead costs of operations for budgetary purposes. For
the first six months of operations, the following data were collected:

Observation Machine-hours Kilowatt-hours Total Overhead Costs

January 3,800 4,520,000 $138,000
February 3,650 4,340,000 136,800
March 3,900 4,500,000 139,200
April 3,300 4,290,000 136,800
May 3,250 4,200,000 126,000
June 3,100 4,120,000 120,000

Required:

a. Use the high-low method to determine the estimating cost function with machine-hours
as the cost driver.

Highest level of Machine-hours is 3900 for Month of March with overhead cost of $139,200
And Lowest is 3,100 for June with overhead cost $120,000.

So variable cost per Machine Hour = (139200-120000)/(3900-3100) = $24

Fixed Cost = 139200-3900*24 = $45,600

So Cost Function = $45600 + Machine Hour*$24

b. Use the high-low method to determine the estimating cost function with kilowatt-hours as the
cost driver.

Highest level of kilowatt-hours is 4,520,000 for Month of January with overhead cost of
$138,000 and Lowest is 4,120,000 for June with overhead cost $120,000.

So variable cost per kilowatt-hour = (138000-120000)/(4,520,000-4,120,000) = $0.045

Fixed Cost = 138000-4520000*.045 = -65400

So Cost Function = -$65400 + kilowatt-hour *$0.045

c. For July, the company ran the machines for 3,000 hours and used 4,000,000 kilowatt-hours of
power. The overhead costs totaled $114,000. Which cost driver was the best predictor for July?

Predicted Cost if machine-hours is used as Cost Driver

= $45600 + Machine Hour*$24
=$45600+3000*24
= $117,600
Predicted Cost if kilowatt-hour is used as Cost Driver
= -$65400 + kilowatt-hour *$0.045
= -65600+4000000*.045
= 114,400

Kilowatt-hour is the better predictor for July as it give the predicted cost which is closer to the
actual cost incurred.