CHAPTER 7 Activity Analysis, Cost Behavior, and Cost Estimation

ANSWERS TO REVIEW QUESTIONS

7-1 Cost behavior patterns are important in the process of making cost predictions. Cost predictions are used in planning, control, and decision making. For example, cost budgets are based on predictions of costs at various levels of activity. Cost control is accomplished by comparing actual costs against budgeted costs, which are based on cost predictions. Cost predictions are also important in decision making, since the desirability of various alternatives often depends on the costs that will be incurred under those alternatives. a. Cost estimation is the process of determining how a particular cost behaves. b. Cost behavior is the relationship between cost and activity. c. Cost prediction is the forecast of cost at a particular level of activity. Cost estimation determines the cost behavior pattern, which is used to make a cost prediction about the cost at a particular level of activity contemplated in the future. 7-! a. "otel# $ercentage of rooms occupied or the number of occupancy-days, where an occupancy-day is defined as one room occupied for one day. b. "ospital# $atient-days, where a patient-day is defined as a one-day stay by one patient. c. Computer manufacturer# %umber of computers manufactured, throughput, engineering specifications, engineering change orders, or number of parts in the finished product. d. Computer sales store# &ales revenue. e. Computer repair service# 'epair calls or hours of repair service. f. $ublic accounting firm# "ours of auditing service provided by each classification of personnel (partner, manager, supervisor, senior accountant, and staff accountant).

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7.* Cost

+raphs of the cost behavior patterns are as follows# Cost

,ctivity a. -ariable Cost Cost b. &tep-variable

,ctivity

Cost

c. Fixed

,ctivity Cost

d. &tep-fixed

,ctivity

e. &emivariable
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,ctivity

f. Curvilinear

,ctivity

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,s the level of activity (or cost driver) increases, total fixed cost remains constant. "owever, the fixed cost per unit of activity declines as activity increases. , manufacturer0s cost of supervising production might be a step-fixed cost, because one supervisor is needed for each shift. 1ach shift can accommodate a certain range of production activity2 when activity exceeds that range, a new shift must be added. 3hen the new shift is added, a new production supervisor must be employed. 4his new position results in a 5ump in the step-fixed cost to a higher level. ,s the level of activity (or cost driver) increases, total variable cost increases proportionately and the variable cost per unit remains constant. a. , semivariable cost behavior pattern can be used to approximate a stepvariable cost as shown in the following graph# Cost &emivariable approximation

7.7 7.6

&tep-variable cost ,ctivity b. , semivariable cost behavior pattern can be used to approximate a curvilinear cost as shown in the following graph# Cost

Curvilinear cost

&emivariable approximation ,ctivity

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7-7

(a) ,nnual cost of maintaining an interstate highway# committed cost. (8nce the highway has been built, it must be maintained. 4he transportation authorities are largely committed to spending the necessary funds to maintain the highway ade9uately.) (b) :ngredients in a breakfast cereal# engineered cost. (c) ,dvertising for a credit card company# discretionary cost. (d) ;epreciation on an insurance company0s computer# committed cost. (e) Charitable donations# discretionary cost. (f) 'esearch and development# discretionary cost.

7-1<

4he cost analyst should respond by pointing out that in most cases a cost behavior pattern should be limited to the relevant range of activity. 3hen the firm0s utility cost was shown as a semivariable cost, it is likely that only some portion in the middle of the graph would fall within the relevant range. 3ithin the relevant range, the firm0s utility cost can be approximated reasonably closely by a semivariable cost behavior pattern. "owever, outside that range (including an activity level of =ero), the semivariable cost behavior pattern should not be used as an approximation of the utility cost. , learning curve shows how average labor time per unit of production changes as cumulative output changes. :n many production processes, as production activity increases and learning takes place, there is a significant reduction in the amount of labor time re9uired per unit. 4he learning phenomenon is important in cost estimation, since estimates must often be made for the level of cost to be incurred after additional production experience is gained. 3ork measurement is the systematic analysis of a task for the purpose of determining the inputs needed to perform the task. 3ork measurement is sometimes used to help in estimating the costs of various nonmanufacturing activities. 4he unit of analysis in work measurement often is called a control factor unit. ,ppropriate control factor units for several tasks are as follows# a. "andling materials at a loading dock# 3eight of materials handled. b. 'egistering vehicles at a county motor vehicle office# %umber of registrations processed.

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7-1

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c. $icking oranges# -olume or weight of oranges picked. d. :nspecting computer components in an electronics firm# %umber of components inspected. 7-1! ,n outlier is a data point that falls far away from the other points in the scatter diagram and is not representative of the data. 8ne possible cause of an outlier is simply a mistake in recording the data. ,nother cause of an outlier is a random event that occurred, which caused the cost during a particular period to be unusually high or low. For example, a power outage may have resulted in unusually high costs of idle time for a particular time period. 8utliers should be eliminated from a data set upon which cost estimates are based. Fixed costs are often allocated on a per unit-of-activity basis. For example, fixed manufacturing-overhead costs, such as depreciation, may be allocated to units of production. ,s a result, such costs may appear to be variable in the cost records. ;iscretionary costs often are budgeted in a manner that makes them appear variable. , cost such as charitable donations, for example, may be fixed once management decides on the level of donations to be made. :f management0s policy is to budget charitable donations on the basis of sales dollars, however, the cost will appear to be variable to the cost analyst. ,n experienced analyst should be wary of allocated and discretionary costs and take steps to learn how the amounts are determined. :n the first step of the visual-fit method of cost estimation, data points are plotted on graph paper to form a scatter diagram. 4hen a line is drawn through the scatter diagram in an attempt to minimi=e the distance between the line and the plotted points. 4he scatter diagram and the visually-fitted cost line provide a valuable first approximation in the analysis of any cost suspected to be semivariable or curvilinear. 4he method is easy to use and to explain to others and provides a useful view of the overall cost behavior pattern. 4he visual-fit method also enables an experienced cost analyst to spot outliers in the data. 4he primary drawbacks of the visual-fit method are its lack of ob5ectivity. 4wo cost analysts may draw two different visually-fitted cost lines. 4he chief drawback of the high-low method of cost estimation is that it uses only two data points. 4he rest of the data are ignored by the method. ,n outlier can cause a significant problem when the high-low method is used if one of the two data points happens to be an outlier. :n other words, if the high activity level happens to be associated with a cost that is not representative of the data, the resulting cost line may not be representative of the cost behavior pattern.

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7-1.

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7-17

4he term least squares in the least-s9uares regression method of cost estimation refers to the process of minimi=ing the sum of the s9uares of the distances between the data and the regression line. , least-s9uares regression line may be expressed in e9uation form as follows# Y = a + bX :n this e9uation, X is referred to as the independent variable, since it is the variable upon which the estimate is based. Y is called the dependent variable, since its estimate depends on the independent variable. 4he intercept of the line on the vertical axis is denoted by a, and the slope of the line is denoted by b. 3ithin the relevant range, a is interpreted as an estimate of the fixed-cost component, and b is interpreted as an estimate of the variable cost per unit of activity.

7-16

7-17 7- <

:n simple regression there is a single independent variable. :n multiple regression there are two or more independent variables. ,dvanced manufacturing technology, such as F>& and C:> systems, have resulted in a shift in the cost structure toward fixed costs. >oreover, many of these fixed costs are committed costs. , particular least-s9uares regression line may be evaluated on the basis of economic plausibility or goodness of fit. 4he cost analyst should always evaluate a regression line from the perspective of economic plausibility. ;oes the regression line make economic sense? :s it intuitively plausible? ,n experienced cost analyst should have a good feel for whether the regression line looks reasonable. &tatistical methods can also be used to determine how well a regression line fits the data upon which it is based. 4his method is referred to as assessing the goodness of fit of the regression. , commonly used measure of goodness of fit is the coefficient of determination, which is described in the appendix at the end of the chapter. 4he coefficient of determination is also denoted by R2.

7. 1

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SO'UTIONS TO E(ERCISES
1@1'C:&1 71. (*< >:%A41&)

Cost of food#

Cost B .,<<< B *,<<< B <,<<<

4otal cost

B1.,<<<

B1<,<<<

B.,<<<

1,<<<

,<<<

!,<<<

$atient days

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1@1'C:&1 7.

(C8%4:%A1;)

Cost of salaries and fringe benefits for administrative staff#

Cost per month

B1 ,<<< B1<,<<<

4otal cost

B.,<<<

1,<<<

,<<<

!,<<<

$atient days

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(C8%4:%A1;)

Caboratory costs#

Cost per month B6<,<<< 4otal cost B7<,<<<

B/<,<<<

B.<,<<<

B*<,<<<

B!<,<<<

B <,<<<

B1<,<<<

1,<<<

,<<<

!,<<<

$atient days

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1@1'C:&1 7*.

(C8%4:%A1;)

Cost of utilities#

Cost per month

B1.,<<<

4otal cost

B1<,<<<

B.,<<<

1,<<<

,<<<

!,<<<

$atient days

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(C8%4:%A1;)

%ursing costs#

Cost per month B17,.<< B1.,<<< B1 ,.<< B1<,<<< B7,.<< B.,<<< B ,.<< << *<< /<< 6<< 1,<<< $atient days 4otal cost

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1@1'C:&1 7- ! (1. >:%A41&) 1. a. b. c. d. . (a) (b) <,<<< miles.................................................................. *<,<<< miles.................................................................. /<,<<< miles.................................................................. 7<,<<< miles.................................................................. ,ctual B!,7<< ., << /,<<< 6,.<< 1stimated B*,*<< ., << /,<<< 7, <<

4he approximation is very accurate in the range *<,<<< to /<,<<< miles per month. 4he approximation is less accurate in the extremes of the longer range, <,<<< to 7<,<<< miles.

1@1'C:&1 7- * (1. >:%A41&) 1. Cost :tem $roduction crew# B*,67.F!7< hr............................................. B6,<<<F/*< hr............................................. &upervisory employees# B.,<<<F!7< hr............................................. B.,<<<F/*< hr............................................. G'ounded. . ;ecember cost predictions# $roduction crew (* < B1 ..< per hr.)............................................. &upervisory employees...................................................................... !. Cost :tem $roduction crew........................................................ &upervisory employees (B.,<<<F* < hr.).................. G'ounded.
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Cost per Droadcast "our Euly &eptember B1 ..< per hr. B1 ..< per hr. 1 .6 per hr.G 7.61 per hr.G

B., .< .,<<<

Cost per Droadcast "our in ;ecember B1 ..< per hr. 11.7< per hr.G

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1@1'C:&1 7- . (1. >:%A41&) 1. -ariable cost per pint of applesauce produced H

B *,1<< B ,1<< = B.1< *1,<<< 1,<<<

4otal cost at *1,<<< pints........................................................................... -ariable cost at *1,<<< pints (*1,<<< B.1< per pint)..................................................................... Fixed cost.................................................................................................... Cost e9uation#

B *,1<< *,1<< B <,<<<

4otal energy cost H B <,<<< I B.1<X, where X denotes pints of applesauce produced . Cost prediction when /,<<< pints of applesauce are produced 1nergy cost H B <,<<< I (B.1<)( /,<<<) H B ,/<<

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1@1'C:&1 7- / (!< >:%A41&) 1. &catter diagram and visually-fitted line#

>onthly energy cost B!<,<<<

B .,<<<

B <,<<<

B1.,<<<

B1<,<<<

B.,<<<

1<,<<<

<,<<<

!<,<<<

*<,<<<

.<,<<<

$ints of apple sauce produced

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1@1'C:&1 7- / (C8%4:%A1;) . ,nswers will vary on this re9uirement because of variation in the visually-fitted lines. Dased on the preceding plot, the cost prediction at /,<<< pounds is# 1nergy cost H B ,/<< !. 4he Euly cost observation at the *<,<<<-pint activity level appears to be an outlier. 4he cost analyst should check the observation data for accuracy. :f the data are accurate, the outlier should be ignored in making cost predictions.

1@1'C:&1 7- 7 (!< >:%A41&) ,nswers will vary widely, depending on the company and costs selected. &ome examples of typical manufacturing costs follow. ;irect material# variable 1lectricity# variable ;epreciation on plant and e9uipment# fixed $lant managerJs salary# fixed $roperty taxes# fixed

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1@1'C:&1 7- 6 (!< >:%A41&) 1. &catter diagram and visually-fitted line#

Cost of diagnostic testing B1<<,<<<

B6<,<<<

B/<,<<<

B*<,<<<

B <,<<<

1,<<<

,<<<

!,<<<

*,<<<

.,<<<

/,<<<

7,<<<

4ests

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1@1'C:&1 7- 6 (C8%4:%A1;) . ,nswers will vary on this re9uirement because of variation in the visually-fitted lines. Dased on the preceding plot# >onthly fixed cost............................................................................................ -ariable cost per diagnostic test..................................................................... GCalculation of variable cost# 4otal cost at 4otal cost at ;ifference# 7, << < 7, << tests........................................... tests........................................... tests........................................... H
B7/,<<< 7, <<

B 6,<<< B 1<../G

B 1<*,<<< 6,<<< B 7/,<<<

-ariable cost per diagnostic test

H B1<../K
K

'ounded.

1@1'C:&1 7- 7 (1. >:%A41&) 1. a. b. c. d. e. . Fixed -ariable -ariable Fixed &emivariable (or mixed)

$roduction cost per month H B!!,<<<G I B .<<X K G!!,<<< H B17,<<< I B1<,<<< I B*,<<<
K

B .<< H B1.1< I B.7< I B. <

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1@1'C:&1 7-!< (1. >:%A41&) 1. -ariable maintenance cost per tour mile H (1 ,.<<r-11,<<<r) F ( <,<<< miles L 6,<<< miles) H .1 .r r denotes the real, Dra=ilJs national currency. 4otal maintenance cost at 6,<<< miles....................................................... -ariable maintenance cost at 6,<<< miles (.1 .r 6,<<<)......................... Fixed maintenance cost per month............................................................ . Cost formula# 4otal maintenance cost per month H 1<,<<<r I .1 .rX , where X denotes tour miles traveled during the month. !. Cost prediction at the >aintenance cost H H ,<<<-mile activity level# 1<,<<<r I (.1 .r)( ,<<<) 1 ,7.<r 11,<<<r 1,<<<r 1<,<<<r

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1@1'C:&1 7-!1 (1. >:%A41&)

>onthly audit cost B1<<,<<< 4otal cost when 1<< audits are performed in a month# B76, << H B1<,<<< I (B/6 ) (1<<) B6<,<<<

B/<,<<<

B*<,<<<

B <,<<< Fixed cost per month# B1<,<<< Control factor units# tax returns audited

<

*<

/<

6<

1<<

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1@1'C:&1 7-! (1< >:%A41&) 1. . !. (a) (b) (a) (b) ,verage time for * satellites.............................................................. ,verage time for 6 satellites.............................................................. 4otal time for * satellites (1!< hr. @ *).............................................. 4otal time for 6 satellites (1<< hr. @ 6).............................................. 1!< hours 1<< hours . < hours 6<< hours

Cearning curves indicate how labor costs will change as the company gains experience with the production process. &ince labor time and costs must be predicted both for budgeting and for setting cost standards, the learning curve is a valuable tool.

1@1'C:&1 7-!! (*. >:%A41&) 1. Ceast-s9uare regression# (a) 4abulation of data# :ndependent -ariable (thousands of passengers) X 1/ 17 1/ 16 1. 17 77

>onth Eanuary....................... February...................... >arch.......................... ,pril............................. >ay.............................. Eune............................ 4otal............................

;ependent -ariable (cost in thousands) Y 16 16 17 < 16 17 11

X ./ 67 ./ ! * . 67 1,/!7

XY 66 !</ !<* !/< 7< ! ! 1,6.1

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1@1'C:&1 7-!! (C8%4:%A1;) (b) Calculation of parameters# a H H b H H (c) Cost formula# >onthly cost of flight service H B7,//7 I B.*.@, where @ denotes thousands of passengers.
( Y )( X ) ( X )( XY ) n( X ) ( X )( X)
(11 )(1,/!7) (77)(1,6.1) = 7.//7 (rounded) (/)(1,/!7) (77)(77)

n( XY) ( X)( Y) n( X 2 ) ( X)( X)

(/)(1,6.1) (77)(11 ) = ..*. (rounded) (/)(1,/!7) (77)(77)

Calculation and interpretation of R # (a) Formula for calculation#

R (Y Y 0) =1 (Y Y)

where

Y Y'
Y

denotes the observed value of the dependent variable (cost) at a particular activity level. denotes the predicted value of the dependent variable (cost) based on the regression line, at a particular activity level. denotes the mean (average) observation of the dependent variable (cost).

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1@1'C:&1 7-!! (C8%4:%A1;) (b) 4abulation of data#G $redicted Cost (in thousands) Dased on 'egression Cine Y' M( Y L Y') NK 16.!67 .1.< 16.7! .6/7 16.!67 .!7/ 17.*77 . 7* 17.6* .< . 16.7! .<<. 1./77

>onth Eanuary.......... February......... >arch............. ,pril................ >ay................. Eune................ 4otal............... GY'

Y
K

Y 16 16 17 < 16 17

X 1/ 17 1/ 16 1. 17

M(Y L Y ) NK .**. .**. .111 1.777 .**. .111 !.!!*

H (B7,//7 I B.*.X)FB1,<<< H OF/ H 16.//7 (rounded)

'ounded.

(c)

Calculation of R # R H1L
1./77 H .*7 (rounded) !.!!*

(d)

:nterpretation of R # 4he coefficient of determination, R , is a measure of the goodness of fit of the least-s9uares regression line. ,n R2 of .*7 means that *7P of the variability of the dependent variable about its mean is explained by the variability of the independent variable about its mean. 4he higher the R , the better the regression line fits the data. 4he interpretation of a high R is that the independent variable is a good predictor of the behavior of the dependent variable. :n cost estimation, a high R means that the cost analyst can be relatively confident in the cost predictions based on the estimated-cost behavior pattern.

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1@1'C:&1 7-!* (*. >:%A41&) 1. -ariable utility cost per hour H

B1,7<< B1,!<< H B .<< 7<< *<<

4otal utility cost at 7<< hours...................................................................... -ariable utility cost at 7<< hours (B .<< 7<< hours)............................... Fixed cost per month................................................................................... Cost formula# >onthly utility cost H B.<< I B .<< X , where X denotes hours of operation. . -ariable-cost estimate based on the scatter diagram on the next page# Cost at Cost at ;ifference /<< hours ....................................................................... < hours ....................................................................... /<< hours .......................................................................

B 1,7<< 1,*<< B .<<

B1,7<< *.< B1, .<

-ariable cost per hour H B1, .<F/<< hr. H B .<6 (rounded)

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1@1'C:&1 7-!* (C8%4:%A1;) &catter diagram and visually-fitted line#

Atility cost per month B ,.<<

B ,<<<

B1,.<<

B1,<<<

B.<<

1<<

<<

!<<

*<<

.<<

/<<

7<< "ours of operation

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1@1'C:&1 7-!* (C8%4:%A1;) !. Ceast-s9uare regression# (a) 4abulation of data# ;ependent -ariable (cost) Y 1,/ < 1,7<< 1,7<< 1,/<< 1,!.< 1,!<< 7,*7< :ndependent -ariable (hours) X ..< /<< 7<< .<< *.< *<< !, <<

>onth Eanuary..................... February.................... >arch........................ ,pril........................... >ay............................ Eune........................... 4otal..........................

X !< ,.<< !/<,<<< *7<,<<< .<,<<< < ,.<< 1/<,<<< 1,7/.,<<<

XY 671,<<< 1,< <,<<< 1,!!<,<<< 6<<,<<< /<7,.<< . <,<<< .,1/6,.<<

(b) Calculation of parameters# a H

( Y )( X ) ( X )( XY ) n( X ) ( X )( X)

H (7,*7<)(1,7/.,<<<) (!, <<)(.,1/6,.<<) = .<1 (/)(1,7/.,<<<) (!, <<)(!, <<)

Y) b H n( XY) ( X)( n( X ) ( X)( X)

H (c) Cost formula# >onthly utility cost -ariable utility cost H B.<1 I B .< X, where X denotes hours of operation. H B .< per hour of operation
(/)(.,1/6,.<<) (!, <<)(7,*7<) = .< (/)(1,7/.,<<<) (!, <<)(!, <<)

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1@1'C:&1 7-!* (C8%4:%A1;) *. Cost predictions at !<< hours of operation# (a) "igh-low method# Atility cost (b) -isually-fitted line# Atility cost H B1,<7. H B.<< I (B .<<)(!<<) H B1,1<<

4his cost prediction was simply read directly from the visually-fitted cost line. 4his prediction will vary because of variations in the visually-fitted lines. (c) 'egression# Atility cost H B.<1 I (B .< )(!<<) H B1,1<7

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SO'UTIONS TO -ROB'E.S
$'8DC1> 7-!. ( < >:%A41&) 1. . !. *. e a g c .. /. 7. 6. b h i f 7. d

1<. k 11. l

%ote that 5 was not used. $'8DC1> 7-!/ ( . >:%A41&) 1. >achine supplies# B1< ,<<< !*,<<< direct-labor hours H B! per hour Eanuary# !,<<< direct-labor hours x B! H B/7,<<< ;epreciation# Fixed at B1.,<<< $lant maintenance cost# >arch (!*,<<< hours) 4otal costGQQQQQQQQ.. Cess# >achine suppliesQQ. ;epreciationQQQQ.. $lant maintenanceQQQQ... B .6/,<<< (1< ,<<<) (1.,<<<) B */7,<<< Eanuary ( !,<<< hours) B *.*,<<< (/7,<<<) (1.,<<<) B !7<,<<<

G 1xcludes supervisory labor cost -ariable maintenance cost H difference in cost difference in direct-labor hours H (B*/7,<<< L B!7<,<<<) (!*,<<< L !,<<<) H B77,<<< 11,<<< hours H B7 per hour

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$'8DC1> 7-!/ (C8%4:%A1;) Fixed maintenance cost# >arch (!*,<<< hours) 4otal maintenance costQQQQQQ. Cess# -ariable cost at B7 per hourQ. Fixed maintenance costQQQQQQ !. >anufacturing overhead at 7,.<< labor hours# >achine supplies at B! per hourQQ. B 66,.<< ;epreciationQQQQQQQQQQQ. 1.,<<< $lant maintenance cost# -ariable at B7 per hourQQQQQ /.,.<< FixedQQQQQQQQQQQQQ. 1/!,<<< &upervisory laborQQQQQQQQQ 7<,<<< 4otalQQQQQQQQQQQ.. B/ ,<<< *. , fixed cost remains constant when a change occurs in the cost driver (or activity base). , step-fixed cost, on the other hand, remains constant within a range but will change (rise or fall) when activity falls outside that range. :deally, the company should operate on the right-most portion of a step, 5ust prior to the 5ump in cost. :n this manner, a firm receives maximum benefit (i.e., the maximum amount of activity) for the dollars invested. B*/7,<<< !</,<<< B1/!,<<< Eanuary ( !,<<< hours) B!7<,<<< <7,<<< B1/!,<<<

..

$'8DC1> 7-!7 ( . >:%A41&) 1. &traight-line depreciationRcommitted fixed Charitable contributionsRdiscretionary fixed >ining laborFfringe benefitsRvariable 'oyaltiesRsemivariable 4rucking and haulingRstep-fixed 4he per-ton mining laborFfringe benefit cost is constant at both volume levels presented, which is characteristic of a variable cost. B!*.,<<< 1,.<< tons H B !< per ton B.76,<<< ,/<< tons H B !< per ton

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$'8DC1> 7-!7 (C8%4:%A1;) 'oyalties have both a variable and a fixed component, making it a semivariable (mixed) cost. -ariable royalty cost H difference in cost difference in tons H (B <1,<<< L B1!.,<<<) ( ,/<< L 1,.<<) H B//,<<< 1,1<< tons H B/< per ton Fixed royalty cost# Eune ( ,/<< tons) 4otal royalty costQQQQQQQQQ. Cess# -ariable cost at B/< per tonQ.. Fixed royalty costQQQQQQQQQ . 4otal cost for 1,/.< tons# ;epreciationQQQQQQQQQQQQQQQQ... B .,<<< Charitable contributionsQQQQQQQQQQQ. --->ining laborFfringe benefits at B !< per tonQQ. !77,.<< 'oyalties# -ariable at B/< per tonQQQQQQQQQQ.. 77,<<< FixedQQQQQQQQQQQQQQQQQQ.. *.,<<< 4rucking and haulingQQQQQQQQQQQQ.. 7.,<<< 4otalQQQQQQQQQQQQQQQQQQ.. B6 !,.<< !. "auling 1,.<< tons is not very cost effective. ,ntioch will incur cost of B 7.,<<< if it needs 1,.<< tons hauled or, for that matter, 1,677 tons. 4he company would be better off if it had 1,*77 tons hauled, saving outlays of B .,<<<. :n general, with this type of cost function, effectiveness is maximi=ed if a firm operates on the right-most portion of a step, 5ust prior to a 5ump in cost. , committed fixed cost results from an entityJs ownership or use of facilities and its basic organi=ational structure. 1xamples of such costs include property taxes, depreciation, rent, and management salaries. ;iscretionary fixed costs, on the other hand, arise from a decision to spend a particular amount of money for a specific purpose. 8utlays for research and development, advertising, and charitable contributions fall in this category. B <1,<<< 1./,<<< B *.,<<< ;ecember (1,.<< tons) B1!.,<<< 7<,<<< B *.,<<<

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$'8DC1> 7-!7 (C8%4:%A1;) :n times of severe economic difficulties, management should try to cut discretionary fixed costs. &uch costs are more easily altered in the short run and do not have significant long-term ramifications for a firm. 4he decision to close a manufacturing facility, for example, could reduce property taxes, rent, andFor depreciation. "owever, that decision may result in a significant long-run change in operations that may be difficult to overturn when economic conditions rebound. .. ,ntioch uses a calendar year for tax-reporting purposes. ,t year-end, it may have ample funds available and decide to make donations to charitable causes. &uch contributions are deductible in computing the companyJs tax obligation to the government. 4ax deductions reduce taxable income and, therefore, produce a tax savings for the firm.

$'8DC1> 7-!6 ( . >:%A41&) 1. -ariable maintenance cost per hour of service H

B*,*7< B ,6 < . < !<<

H B7..< 4otal maintenance cost at !<< hours of service........................................ -ariable maintenance cost at !<< hours of service (!<< hr. B7..<)...... Fixed maintenance cost per month............................................................ Cost formula# >onthly maintenance cost H B.7< I B7..<X, where X denotes hours of maintenance service. . !. 4he variable component of the maintenance cost is B7..< per hour of service. Cost prediction at .7< hours of activity# >aintenance cost H B.7< I (B7..<)(.7<) H B*,77. B ,6 < , .< B .7<

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$'8DC1> 7-!6 (C8%4:%A1;) *. -ariable cost per hour Mfrom re9uirement ( )N........................................... Fixed cost per hour at /<< hours of activity (B.7<F/<<)............................ 4he fixed cost per hour is a misleading amount, because it will change as the number of hours changes. For example, at .<< hours of maintenance service, the fixed cost per hour is B1.1* (B.7<F.<< hours). $'8DC1> 7-!7 (1. >:%A41&) ,n appropriate activity measure for the school would be hours of instruction. 4he costs are classified as follows# 1. . !. *. .. Fixed Fixed -ariable &emivariable (or mixed)G Fixed /. 7. 6. 7. -ariable Fixed Fixed &emivariable (or mixed) B7..< B .7.

G4he fixed-cost component is the salary of the school0s repair technician. ,s activity increases, one would expect more repairs beyond the technician0s capability. 4his increase in repairs would result in a variable-cost component e9ual to the dealer0s repair charges.

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$'8DC1> 7-*< (*< >:%A41&)

4otal course maintenance cost B1 ,.<<

B1 ,*<<

. &emivariable cost approximation

1. &tep-variable component of maintenance cost

B1 ,!<<

B1 , <<

B1 ,1<<

B1 ,<<< 1. Fixed component of maintenance cost

<

.<

1<<

1.<

<<

.<

!<< %umber of golfers

4he lower part of the vertical axis has been shortened.

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$'8DC1> 7-*< (C8%4:%A1;) !. Fixed-cost component H B1 ,<1< -ariable-cost component# -ariable cost H per golfer Cost e9uation# >aintenance cost per month H B1 ,<1< I B X, where X denotes the number of golfers during the month. *. $redicted Course >aintenance Costs Asing Fixed Cost Coupled with &tep-ariable Cost Dehavior $attern B1 ,!<< 1 ,! <
B1 ,*1< B1 ,<1< << <

H B

1.< people tee off................................ 1.6 people tee off................................

Asing &emivariable Cost ,pproximation B1 ,!1< 1 ,! /

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$'8DC1> 7-*1 (*< >:%A41&)

>aterial-handling costs B1 ,.<<

B1 ,<<<

B11,.<<

B11,<<<

B1<,.<<

. -isually-fitted cost line

B1<,<<<

B7,.<<

.<< 4he lower part of the vertical axis has been shortened.

1,<<<

1,.<<

,<<<

,.<<

Control factor units

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$'8DC1> 7-*1 (C8%4:%A1;) . !. &ee graph for re9uirement (1). 4he estimate of the fixed cost is the intercept on the vertical axis. Fixed-cost component H B7,7<< 4o estimate the variable-cost component, choose any two points on the visually-fitted cost line. For example, choose the following points# ,ctivity <.............................................................................................. ,<<<........................................................................................ Cost B 7,7<< 11,7<<

4hen proceed as follows to estimate the variable-cost component# -ariable cost per control factor unit H
B11,7<< B7,7<< ,<<< <

H B1.<< *. Cost e9uation# 4otal material-handling cost H B7,7<< I B1.<<X, where X denotes the number of control factor units of activity during the month. .. "igh-low method# -ariable cost per control factor unit H
B1 ,1 < B1<, << ,/<< 1,<<<

H B1. < 4otal cost at ,/<< control factor units........................................................ ;educt# -ariable cost at ,/<< control factor units ( ,/<< B1. <)........... Fixed cost....................................................................................................... Cost e9uation based on high-low method# >aterial-handling cost per month H B7,<<< I B1. <X, where X denotes the number of control factor units of activity during the month. B1 ,1 < !,1 < B 7,<<<

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$'8DC1> 7-*1 (C8%4:%A1;) /. ;ate# 4o# From# 4oday $resident, >arthaJs -ineyard >arine &upply :.>. &tudent >emorandum

&ub5ect# >aterial-handling cost estimates 8n the basis of a scatter diagram and visually-fitted cost line, the >aterial-"andling ;epartment0s monthly cost behavior was estimated as follows# >aterial-handling cost per month H B7,7<< I B1.<< per control factor unit , control factor unit is defined in this department as 1<< pounds of e9uipment loaded or unloaded at the loading dock. Asing the high-low method, the following cost estimate was obtained# >aterial-handling cost per month H B7,<<< I B1. < per control factor unit 4he two methods yield different estimates because the high-low method uses only two data points, ignoring the rest of the information. 4he method of visually fitting a cost line, while sub5ective, uses all of the data available. :n this case, the two data points used by the high-low method do not appear to be representative of the entire set of data. 7. $redicted >aterial-"andling Costs Asing -isually-Fitted Cost CineG B1 ,<<< H B7,7<< I (B1.<<)( ,!<<) Asing "igh-Cow >ethod B11,7/< H B7,<<< I (B1. <)( ,!<<)

G4his method is preferable, because it uses all of the data.

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$'8DC1> 7-* (*. >:%A41&) 1. Ceast-s9uares regression# (a) 4abulation of data# ;ependent -ariable (cost in thousands) Y 11.!. 11.!. 11.<. 1 .1 11.*< 1 .<< 1 ... 11.1< 1<. < 11. . 11.!< 11.7< 1!7.!7 :ndependent -ariable (units of activity in thousands) X 1.* 1. 1.1 ./ 1.6 .< .* . 1.< 1.! 1./ 1.6 <.*

>onth Eanuary....................... February...................... >arch.......................... ,pril............................. >ay.............................. Eune............................ Euly.............................. ,ugust........................ &eptember.................. 8ctober....................... %ovember................... ;ecember.................... 4otal............................

X 1.7/ 1.** 1. 1 /.7/ !. * *.<< ..7/ *.6* 1.<< 1./7 ../ !. * !7.7<

XY 1..67< 1!./ < 1 .1.. !1..1 <.. < *.<<< !<.1 < *.* < 1<. << 1*./ . 16.<6< 1.</< !/. <

(b) Calculation of parameters# a H H b H H

( Y )( X ) ( X )( XY ) n( X ) ( X )( X)
(1!7.!7)(!7.7) ( <.*)( !/. < ) = 7.7*! (rounded) (1 )(!7.7) ( <.*)( <.*)

n( XY) ( X)( Y) n( X 2 ) ( X)( X)

(1 )( !/. < ) ( <.*)(1!7.!7) =.66. (rounded) (1 )(!7.7) ( <.*)( <.*)

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$'8DC1> 7-* (C8%4:%A1;) (c) Fixed- and variable-cost components# >onthly fixed cost H B7,7*!G -ariable cost H B.67 per control factor unit (rounded)K G4he intercept parameter (a) computed above is the cost per month in thousands. K 4he slope parameter (b) calculated above is the cost in thousands of dollars per thousand units of activity. 19uivalently, it is the cost per unit of activity. . !. 4otal monthly cost H B7,7*! I B.67 per control factor unit Cost prediction for ,!<< control factor units of activity# 4otal monthly cost H B7,7*! I (B.67)( ,!<<) H B11,77< *. 4he cost predictions differ because the cost formulas differ under the three costestimation methods. 4he high-low method, while ob5ective, uses only two data points. 4en observations are excluded. 4he visual-fit method, while it uses all of the data, is somewhat sub5ective. ;ifferent analysts may draw different cost lines. Ceast-s9uares regression is ob5ective, uses all of the data, and is a statistically sound method of estimation. 4herefore, least-s9uares regression is the preferred method of cost estimation.

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$'8DC1> 7-*! ( . >:%A41&) 1. &catter diagrams#

$resent, in graphic form, the relationship between costs and cost drivers via a plot of data points 'e9uire that a straight line be fit through the data points, with approximately the same number of data points above and below the line 1asy to use $rovide a means to easily recogni=e outliers Ceast-s9uares regression# Ases statistical formulas to fit a cost line through the data points :s a very ob5ective method of cost estimation that uses all the data points 'e9uires more computation than other cost-estimation methods2 however, software programs are readily available "igh-low method# 'elies on only two data points (for the highest and lowest activity levels) in drawing conclusions about cost behavior :s considered more ob5ective than the scatter diagram2 however, is weaker than the scatter diagram because it relies on only two data points 4he least-s9uares regression method will typically produce the most accurate results. . Oes. 4he three methods produce e9uations by different means. &catter diagrams and least-s9uares regression rely on an examination of all data points. 4he scatter diagram, however, re9uires an analyst to fit a line through the points by visual approximation, or Seyeballing.T :n contrast, least-s9uares regression involves the use of statistical formulas to derive the best possible fit of the line through the points. Finally, the high-low method is based on an analysis of only two data points# the highest and the lowest activity levels.

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$'8DC1> 7-*! (C8%4:%A1;) !. 4hese amounts represent the fixed and variable cost associated with the ticketing operation. Fixed cost totals B!1 ,<<< within the relevant range, and +lobal ,merican incurs B .!< of variable cost for each ticket issued. C H B! <,<<< I B .1.$4 C H B! <,<<< I (B .1. x .6<,<<<) C H B1,./7,<<< Oes, she did err by including %ovember data. %ovember is not representative because of the effects of the ;elta 3estern strike. 4he month is an outlier and should be eliminated from the data set. Currently, most of the airlineJs tickets are written through reservations personnel, whose wages are likely variable in nature. "eavier reliance on the :nternet means a greater investment in software, 3eb-site maintenance and development, and other similar expenditures. 8utlays that fall in these latter categories are typically fixed costs, assuming that the cost driver is the number of tickets. 4he outcome would parallel the experiences of a manufacturing firm that automates its processes and reduces its reliance on direct-labor personnel.

*.

..

/.

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$'8DC1> 7-** (!. >:%A41&) 1. 4he regression e9uation0s intercept on the vertical axis is B <<. :t represents the portion of indirect material cost that does not vary with machine hours when operating within the relevant range. 4he slope of the regression line is B* per machine hour. For every machine hour, B* of indirect material costs are expected to be incurred. 1stimated cost of indirect material at 7<< machine hours of activity# S H B << I (B* 7<<) H B!,6<< !. &everal 9uestions should be asked# (a) (b) ;o the observations contain any outliers, or are they all representative of normal operations? ,re there any mismatched time periods in the data? ,re all of the indirect material cost observations matched properly with the machine hour observations? ,re there any allocated costs included in the indirect material cost data? ,re the cost data affected by inflation? ,pril B1, << /,<<< (1,..<) B.,/.< ,ugust B 7.< /,1<< ( ,7<<) B*,1.<

(c) (d) *.

Deginning inventory............................................................. I $urchases.......................................................................... L 1nding inventory............................................................... :ndirect material used.......................................................... .. "igh-low method# -ariable cost per machine hour H H
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difference in cost levels difference in activity levels

B.,/.< B*,1.< B1,.<< = = B. per machine hour 1,1<< 6<< !<<

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$'8DC1> 7-** (C8%4:%A1;) Fixed cost per month# 4otal cost at 1,1<< hours............................................................................... -ariable cost at 1,1<< hours (B. 1,1<<).............................................................................................. Fixed cost....................................................................................................... 19uation form# :ndirect material cost H B1.< I (B. machine hours) /. 4he regression estimate should be recommended because it uses all of the data, not 5ust two pairs of observations. B.,/.< .,.<< B 1.<

$'8DC1> 7-*. (*< >:%A41&) 1. 4he original method was simply the average overhead per hour for the last 1 months and did not distinguish between fixed and variable costs. 'and divided total overhead by total labor hours, which effectively treated all overhead as variable. 'egression analysis measures the behavior of the overhead costs in relation to labor hours and is a model that distinguishes between fixed and variable costs within the relevant range of ,.<< to 7,.<< labor hours. a. Dased on the regression analysis, the variable cost per person for a cocktail party is B , calculated as follows# Food and beverages............................................................................... Cabor (.. hr. U B1<Fhr.)........................................................................... -ariable overhead (.. hr. U B*Fhr.)........................................................ 4otal................................................................................................... B1. . B

b. Dased on the regression analysis, the full absorption cost per person for a cocktail party is B 7, calculated as follows# Food and beverages............................................................................... Cabor (.. hr. U B1<Fhr.)........................................................................... -ariable overhead (.. hr. U B*Fhr.)........................................................ Fixed overhead (.. hr. U B1<Fhr.)G......................................................... 4otal...................................................................................................
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$'8DC1> 7-*. (C8%4:%A1;) GB*6,<<< x 1 months H B.7/,<<< B.7/,<<<F.7,/<< hr. H B1<Fhr. !. 4he minimum bid for a <<-person cocktail party would be B*,*<<. 4he amount is calculated by multiplying the variable cost per person of B by << people. ,t any price above the variable cost, ;ana 'and will be earning a contribution toward her fixed costs. 8ther factors that ;ana 'and should consider in developing a bid include the following#

*.

4he assessment of the current capacity of her business. :f the business is at capacity, other work would have to be sacrificed at some opportunity cost. ,nalyses of the competition. :f competition is rigorous, she may not have much bargaining power. , determination of whether or not her bid will set a precedent for lower prices. 4he reali=ation that regression analysis is based on historical data, and that any anticipated changes in the cost structure should be considered.

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$'8DC1> 7-*/ (*. >:%A41&) Cost of 8perating the Applications ,dmissions Received 8ffice (in thousands) (in thousands) X Y < 6.7 !< 1<.< . 7./ 7.1 1. 6.7 1< 6.< 1 .*.!

>onth ,ugust........................ &eptember.................. 8ctober....................... %ovember................... ;ecember.................... Eanuary....................... 4otal............................ a.

X *<< 7<< / . *6* . 1<< ,7!*

XY 176.< !<<.< *<.< <<. 1!<.. 6<.< 1,1 6.7

Ceast-s9uares regression# 7.<7/G H .<77G H

(.*.!)( ,7!*) (1 )(1,1 6.7) (/)( ,7!*) (1 )(1 )

(/)(1,1 6.7) (1 )(.*.!) (/)( ,7!*) (1 )(1 )

4otal monthly admissions department costs H B7,<7/ I B.<77 X, where X denotes the number of applications in thousands. G'ounded.

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$'8DC1> 7-*/ (C8%4:%A1;) b. "igh-low method# -ariable cost per thousand applications H
1< 6 = !< 1< <

H B.1< 4otal cost at !< thousand applications............................................. -ariable cost at !< thousand applications (!<,<<< B.1<).............. Fixed cost per month......................................................................... 4otal monthly admissions department costs c. -isual-fit method# 4otal monthly admissions department costs H B7,1<< I B.<7.X H B7,<<< I B.1<X B1<,<<< !,<<< B 7,<<<

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$'8DC1> 7-*7 (*. >:%A41&) 1. &catter diagram#

,irport costs B!<,<<<

B .,<<<

B <,<<<

B1.,<<<

B1<,<<<

B.,<<<

.<

.<<

7.<

1,<<<

1, .<

1,.<<

1,7.< Flights

%ote# 8nly 11 data points appear, because two monthly observations were identical (>ay and &eptember).
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$'8DC1> 7-*7 (C8%4:%A1;) . Ceast-s9uares regression# (a) 4abulation of data# ;ependent -ariable (cost in thousands) Y < 17 17 16 17 < 16 * 17 1 17 1 !! :ndependent -ariable (flights in hundreds) X 11 6 1* 7 1< 1 11 1* 1< 1 7 1. 1!.

>onth Eanuary....................... February...................... >arch.......................... ,pril............................. >ay.............................. Eune............................ Euly.............................. ,ugust........................ &eptember.................. 8ctober....................... %ovember................... ;ecember.................... 4otal............................

X 1 1 /* 17/ 61 1<< 1** 1 1 17/ 1<< 1** 61 . 1,.7!

XY < 1!/ // 1/ 17< *< 176 !!/ 17< . 1.! !1. ,/.6

(b) Calculation of parameters# ( Y )( X ) ( X )( XY ) a H n( X ) ( X )( X) H b H

( !!)(1,.7!) (1!.)( ,/.6) = 11.77/ (rounded) (1 )(1,.7!) (1!.)(1!.)

n( XY) ( X)( Y) n( X 2 ) ( X)( X)

(1 )( ,/.6) (1!.)( !!)

H (1 )(1,.7!) (1!.)(1!.) =./77 (rounded)

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$'8DC1> 7-*7 (C8%4:%A1;) (c) Fixed- and variable-cost components# >onthly fixed cost H B11,77/ -ariable cost H B/77 per hundred flights !. Cost e9uation# 4otal monthly airport cost H B11,77/ I B/77 X, where X denotes the number of flights in hundreds. *. Cost prediction for 1,/<< flights# ,irport cost for the month H B11,77/ I (B/77)(1/) H B ,/ 6 .. Calculation and interpretation of R # (a) Formula for calculation#
(Y Y 0) R = 1 (Y Y)

where

Y Y0
Y

denotes the observed value of the dependent variable (cost) at a particular activity level. denotes the predicted value of the dependent variable (cost) based on the regression line, at a particular activity level. denotes the mean (average) observation of the dependent variable (cost).

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$'8DC1> 7-*7 (C8%4:%A1;) (b) 4abulation of data#G $redicted Cost (in thousands) Dased on 'egression Cine Y' M( Y Y') NK 17. *! ..7! 17. 1 .<*. 1. 7* ..171 17.667 .<1 16..// .166 17.7 < .<</ 17. *! 1..*. 1. 7* 7.*!1 16..// .166 17.7 < 1.1// 17.667 .77< 1.7.1 .7<* 16.<17

>onth Eanuary.......... February......... >arch............. ,pril................ >ay................. Eune................ Euly................. ,ugust............ &eptember..... 8ctober.......... %ovember...... ;ecember....... 4otal............... GY'
Y
K

Y < 17 17 16 17 < 16 * 17 1 17 1

X 11 6 1* 7 1< 1 11 1* 1< 1 7 1.

M(Y L Y ) NK .!*< ..6* .17* .<<6 .17* .!*< .<<6 1.<<* .17* ..</ ..6* ..</ * .716

H (B11,77/ I B/77X)FB1,<<< H OF1 H !!F1 H 17.*17 (rounded)

'ounded.

(c)

Calculation of R # R H1L
16.<17 H ..6 (rounded) * .716

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$'8DC1> 7-*7 (C8%4:%A1;) (d) :nterpretation of R # 4he coefficient of determination, R , is a measure of the goodness of fit of the least-s9uares regression line. ,n R of ..6 means that .6P of the variability of the dependent variable about its mean is explained by the variability of the independent variable about its mean. 4he higher the R , the better the regression line fits the data. 4he interpretation of a high R is that the independent variable is a good predictor of the behavior of the dependent variable. :n the countyJs cost estimation, a high R would mean that the county budget officer can be relatively confident in the cost predictions based on the estimated-cost behavior pattern. ,n R of ..6 is not particularly high.

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SO'UTIONS TO CASES
C,&1 7-*6 (*. >:%A41&) 1. Cairns0 preliminary estimate for overhead of B16.<< per direct-labor hour does not distinguish between fixed and variable overhead. 4his preliminary rate is applicable only to the activity level at which it was computed (!/,<<< direct-labor hours per year) and may not be used to predict total overhead at other activity levels. 4he overhead rate developed from the least-s9uares regression recogni=es the relationship between cost and volume in the data. 4he regression suggests that there is a component of the cost (B /, << per month) that is unrelated to total direct-labor hours. 4his cost component is the intercept on the vertical axis and is often considered to be the fixed cost as long as the activity level is within the relevant range. 4hus, the least-s9uares regression results in a cost function with two components# fixed cost per month and variable cost per direct-labor hour. 4his cost formula can be used to predict total overhead at any activity level. . ;irect material............................................................................................... ;irect labor (. ;C"G B1<.<< per ;C")....................................................... -ariable overhead (. ;C" B7. . per ;C")............................................... 4otal variable cost per 1,<<< s9uare feet.................................................... G;C" denotes direct-labor hour. !. 4he minimum bid should include the following incremental costs of the pro5ect.# ;irect material (B*<<.<< /<)...................................................................... ;irect labor (B.<.<< /<)............................................................................. -ariable overhead (B7. . per ;C" . ;C" /<)....................................... 8vertime premium (B..<< per ;C" . ;C" /< .*).............................. >inimum bid.................................................................................................. *. B *,<<< !,<<< ,77. /<< B!<,!7. B*<<.<< .<.<< */. . B*7/. .

Oes, Cairns can rely on the formula as long as she recogni=es that there are some shortcomings. 4he fact that least-s9uares regression estimates cost behavior increases the usefulness of rates computed from cost data. "owever, the regression is based on historical costs that may change in the future, and Cairns must assess whether the cost e9uation would need to be revised for future cost increases or decreases.

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C,&1 7-*6 (C8%4:%A1;) .. a. -ariable 8"1 (/< . B*.1<)............................................................... -ariable 8" (/< B1!..<).................................................................... -ariable 8"! (6< B/./<)...................................................................... 4otal incremental variable overhead................................................... -ariable 8"1 (/< . B*.1<)............................................................... -ariable 8" (!< B1!..<).................................................................... -ariable 8"! ( .< B/./<).................................................................... 4otal incremental variable overhead................................................... B1, !< 61< . 6 B ,./6 B1, !< *<. 1,/.< B!, 6.

b.

c.

4he two scenarios in (a) and (b) differ in terms of the activities to be undertaken. &cenario (a) involves a large amount of seeding activity and relatively little planting activity. &cenario (b) involves considerably less seeding activity, but a great deal more planting activity. ,n activity-based costing system accounts for the different costs in pro5ects involving different mixes of activity.

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C,&1 7-*7 (*. >:%A41&) 1. &catter diagram#

,dministrative cost B .,<<<

B <,<<<

B1.,<<<

. -isually-fitted curvilinear cost line *. -isually-fitted semivariable cost line

B1<,<<<

B.,<<<

$atient load

.<<

1,<<<

1,.<<

,<<<

!. 'elevant range

. through *.

&ee scatter diagram for re9uirement (1).

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C,&1 7-*7 (C8%4:%A1;) .. Fixed cost H B/,7<<

-ariable cost per patient = B1<,/<< B/,7<< = B!.<6 (rounded) 1, << <

/. 7.

,dministrative cost H B/,7<< I B!.<6X, where X denotes the number of patients. Cost predictions# $atient Cost Coad $rediction 6<<............................ B7,!<< !<<............................ *,<<< :t makes no difference which cost line is used to make the cost prediction for 6<< patients. 4he semivariable approximation is very accurate at this patient load, which is near the middle of the relevant range. "owever, for a patient load of !<< patients, the curvilinear cost line yields a much more accurate prediction.

C,&1 7-.< (.< >:%A41&) 1. "igh-low method# -ariable administrative cost per patient H
B1/,1<< B*,1<< = B1< 1,.<< !<<

4otal cost at 1,.<< patients........................................................................... -ariable cost at 1,.<< patients...................................................................... Fixed cost per month.................................................................................... Cost formula#

B1/,1<< 1.,<<< B1,1<<

4otal monthly administrative cost H B1,1<< I B1<X, where X denotes the number of patients for the month. 4he variable cost per patient is B1<.

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C,&1 7-.< (C8%4:%A1;) . Ceast-s9uares regression# (a) 4abulation of data# ;ependent -ariable (cost in hundreds) Y 1!7 7< /< 1<< 117 7 1< *1 7* 111 6! 1/1 1,17 :ndependent -ariable (patients in hundreds) X 1* . * 1< 1! 7 11 ! 7 1 / 1. 1<7

>onth Eanuary....................... February...................... >arch.......................... ,pril............................. >ay.............................. Eune............................ Euly.............................. ,ugust........................ &eptember.................. 8ctober....................... %ovember................... ;ecember.................... 4otal............................

X 17/ . 1/ 1<< 1/7 61 1 1 7 *7 1** !/ . 1,171

XY 1,7*/ !.< *< 1,<<< 1,.*7 6 6 1,1 1 ! /.6 1,!! *76 ,*1. 1 ,<.7

(b) Calculation of parameters# ( Y )( X ) ( X )( XY ) a H n( X ) ( X )( X) H b H H

(1,17 )(1,171) (1<7)(1 ,<.7) = /.7<7 (rounded) (1 )(1,171) (1<7)(1<7)

n( XY) ( X)( Y) n( X 2 ) ( X)( X)

(1 )(1 ,<.7) (1<7)(1,17 ) = 7.61 (1 )(1,171) (1<7)(1<7) (rounded)

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C,&1 7-.< (C8%4:%A1;) (c) Cost behavior in formula form (with rounded parameters)#G 4otal monthly administrative cost H B ,/71 I B7.61X, where X denotes the number of patients for the month. G3hen interpreting the regression parameters, remember that both the cost and patient data were transformed to hundreds. 4hus, the /.7<7 intercept parameter (a) is in terms of hundreds of dollars of cost, or B ,/71 (rounded). 4he 7.61 slope parameter (b) is in terms of hundreds of dollars of cost per hundred patients, or B761 (rounded) per hundred patients. 4his amount is e9uivalent to B7.61 per patient. (d) !. ;ate# 4o# From# 4oday Eeffrey >ahoney, ,dministrator :.>. &tudent 4he variable cost per patient is B7.61, as explained above. >emorandum

&ub5ect# Comparison of cost estimates for clinic administrative costs 4hree alternative cost-estimation methods were used to estimate the pediatric clinic0s administrative cost behavior. 4he results of these three approaches (in formula form) are shown below. :n each formula, X denotes the number of patients in a month. (a) Ceast-s9uares regression method# 4otal monthly administrative cost H B ,/71 I B7.61X (b) "igh-low method# 4otal monthly administrative cost H B1,1<< I B1<X

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C,&1 7-.< (C8%4:%A1;) (c) -isual-fit method# 4otal monthly administrative cost H B/,7<< I B!.<6X 4hese cost estimates differ very significantly. 4he activity level in the clinic during its first year of operation fluctuated greatly. 4his fluctuation is not expected in the future2 patient loads in the range of /<< to 1, << patients per month are anticipated. 4he cost estimates differ so greatly because two of the methods (leasts9uares and high-low) used data from outside the relevant range of activity. 4he clinic0s administrative cost behavior appears from the scatter diagram to be curvilinear over the entire range. 4he cost behavior pattern exhibits very low costs in the range of activity below the relevant range and very high costs in the activity range above the relevant range. &ince the regression and high-low estimates are so heavily influenced by observations outside the relevant range, they do not provide the best estimate in this case of how administrative costs are likely to behave within the relevant range. :n this instance, the visually-fitted cost line probably provides the best estimate. 4he visually-fitted cost line has a much flatter slope than the other two cost lines, indicating that total variable administrative costs will probably rise at about B!. . per patient. ,nother possible approach would be to use least-s9uares regression, but restrict the data to those observations within the relevant range. "owever, only a handful of observations would remain to include in the analysis. >y overall recommendation is to use the visually-fitted cost line as the best estimate until the clinic has operated for its second year. 4hen : would recommend a new cost analysis using least-s9uares regression on all of the data from the relevant range of activity.

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C,&1 7-.< (C8%4:%A1;) *. :t is very inappropriate for the hospital administrator to manipulate the cost information supplied by the controller in order to push his own agenda before the board of trustees. :t is the board0s legitimate role to decide whether or not to establish and continue operations in the clinic. :n making decisions about the clinic, the board should have the best information possible, including the controller0s best estimate as to how administrative costs will behave. >egan >c;onough, the hospitalJs ;irector of Cost >anagement, has a professional obligation to provide her best professional 5udgment to the board of trustees. 4he standards of ethical conduct for management accountants include the following re9uirements concerning ob5ectivity# (a) Communicate information fairly and ob5ectively.

(b) ;isclose fully all relevant information that could reasonably be expected to influence an intended user0s understanding of the reports, comments, and recommendations presented. >c;onough should insist that the best and most appropriate estimate of the clinic0s administrative cost behavior be presented to the board.

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CURRENT ISSUES IN .ANA/ERIA' ACCOUNTIN/

:&&A1 7-.1 V;'A+-$':C1 $'8+',> %841&,V !"# $A%% S!R##! &'(R)A%, ,A+A&4 1<, <<<. 1. , fixed cost is a cost that will not change in total as production levels change within the relevant range. Common examples include straight-line depreciation, supervisory salaries, and rent. 4he pharmaceutical industry has high fixed costs and low variable costs. :ts high fixed costs are Sbaked in the cakeT because of the research and development necessary to yield a profitable drug. 4herefore, research and development is a fixed cost of the drug industry. -ariable costs are low because, after the discovery and approval process has been completed, it0s not very expensive to manufacture the pills. . , variable cost is a cost that will change in total as production levels change. ;irect material and electricity are often classified as variable costs. >any costs are semivariable (or mixed)2 they contain both variable and fixed cost components.

:&&A1 7-. V;1C4,, %8'4"31&4 $8&4 &4'8%+ %14 ;1&$:41 FA1C C8&4&, ":+"1' F,'1&,V !"# $A%% S!R##! &'(R)A%, EACO 1, <<<, >,'4", D',%%:+,% ,%; >:C",1C E. >CC,'4"O. 1. Fuel costs are variable. 4he distance flown, as well as the weight of the cargo andFor passengers, determines how much fuel is used during a flight. . ,n airline would benefit from estimating costs since management needs cost information to schedule routes and determine the sales price of tickets. :&&A1 7-.! V,:'DA& 0C'A:&1 &":$ :% 4"1 &WO0,V !"# $A%% S!R##! &'(R)A%, ,A+A&4 !<, <<<, E1FF C8C1 ,%; ;,%:1C >:C",1C&. 1. &ignificantly different costs would be the variable costs per passenger such as fuel, food, and personnel costs for the flight attendants. :ncreased costs of hangar space due to the si=e of the plane would be considered fixed costs. . >aintenance costs for a new aircraft are always difficult to predict.
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!. ,n airline would benefit from estimating costs. >anagement needs cost estimates to schedule routes and to determine the sales price of tickets.

:&&A1 7-.* V;1C4, $:C84&0 A%:8% $'8$8&1& $,O ',:&1& >,W:%+ &,C,':1& ":+"1' 4",% A%:41;0&,V !"# $A%% S!R##! &'(R)A%, 8C48D1' 1/, <<<, >,'4", D',%%:+,%. 1. $ilots0 salaries are considered a fixed cost of a particular flight, in the sense that the cost would not vary with respect to the number of passengers. "owever, pilotsJ salaries do vary with the number of flights and their length. ,n airline would benefit from estimating costs. >anagement needs cost estimates to schedule routes and to determine the sales price of tickets.

:&&A1 7-.. V"8&$:4,C& :% %" $8&4 >8'1 C8&&1&,V !"# $A%% S!R##! &'(R)A%, ,$':C /, <<<, E,>1& D,%;C1'. 1. Fixed costs are costs that remain the same in total as the volume of activity changes. . &haring laboratory expenses with other hospitals would be an example of a way to reduce fixed costs.

:&&A1 7-./ V"8CCO388; 'A&"1& 48 D1,4 , &4':W1,V *(S+)#SS $##,, E,%A,'O 6, <<1, '8%,C; +'8-1'. 1. 3ill &mith will receive B < million and <P of revenues. 4his is a semivariable cost. . Colin Farrell will receive B .. million for 4igerland. 4his is a fixed cost.

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