CALAMBA DOCTORS COLLEGE

Cost Accounting

ACTIVITY BASE ANALYSIS, COST BEHAVIOR, AND COST ESTIMATION

Earth and Artistry, Inc. provides commercial landscaping services. Sasha Cairns, the firms owner. Wants to
develop cost estimate that she can uses to prepare bids on jobs. After analyzing the firms costs, Cairns has
developed the following preliminary cost estimate for each 1,000 square feet of landscaping.
Direct material
$400
Direct labor (5 direct-labor hours at $10 per hour)
50
Overhead (at $18 per direct-labor hour)
90
Total cost per 1,000 square feet
$540
Cairns is quite certain about the estimates for direct material and direct labor. However, she is not as
comfortable with the overhead estimate. The estimate for overhead is based on the overhead costs that were
incurred during the past 12 months as presented in the following schedule. The estimate of $18 per directlabor hour was determined by diving the total overhead costs for the 12-month period ($648,000) by the
total direct labor hours (36,000).
Total Overhead

Regular Direct
Labor Hours

Overtime Direct
Labor Hours*

Total Direct
Labor Hours

January
$ 54,000
2,190
190
3,100
February
47,000
2,380
20
2,400
March
48,000
2,210
40
2,250
April
56,000
2,590
210
2,800
May
57,000
3,030
470
3,500
June
65,000
3,240
760
4,000
July
64,000
3,380
620
4,000
*The Overtime premium is 50 percent of the direct-labor wage rate.
Cairns believes that overhead is affected by the total monthly direct-labor hours. Cairns decided to perform a least-squares
regression of overhead (OH) on total direct-labor hours (DLH). The following regression formula was obtained.
OH= 26,200 + 9.25DLH
Required:
1. The Overhead rate developed from the least-squares regression is different from Cairns preliminary estimate of $18 per
direct-labor hour. Explain the difference in the two overhead rates.
2. Using the overhead formula that was derived from the least-squares regression, determine a total variable-cost estimate for
each 1,000 square feet of landscaping.
3. Cairns has been asked to submit a bid on a landscaping project for the city government consisting of 60,000 square feet.
Cairns estimates that 40 percent of the direct-labor hours required for the project will be on overtime. Calculate the
incremental costs that should be included in any bid thats Cairns would submit on this project. Use the overhead formula
derived from the least-squares regression.
4. Should Management rely on the overhead formula derived from the least-squares regression as the basis for the variable
overhead component of its cost estimate? Explain your Answer.
5. After attending a seminar on activity-based costing. Cairns decided to further analyze the companys activities and costs. She
discovered that a more accurate portrayal of the firms cost behavior could be achieved by dividing overheard into three
separates pools, each with its own driver. Separate regression equations were estimated for each of the costs pools, with the
following results.
OH1 = 10,000 + 4.10DLH
Where DLH denotes direct-labor hours
OH2= 9,100 + 13.50FS,
Where SFS denotes the number of square feet of turf seeded (in thousands)
OH3 = 8,000 + 6.60PL,
Where PL denotes the number of individual plantings, (e.g., trees and shrubs)
Assume that 5 direct-labor hours will be needed to landscape each 1,000 square feet regardless of the specific planting material
used.
a. Suppose the landscaping project for the city will involve seeding all 60,000 square feet of turf and planting 80 trees and
shrubs. Calculate the incremental variable overhead cost that Cairns should include in the bid.
b. Re compute the incremental variable overhead costs for the citys landscaping project assuming half of the 60,000- squarefoot landscaping area will be seeded will be there will be 250 individual plantings. The plantings. Will cover the entire
60,000- square foot area.
c. Briefly explain using concepts from activity based costing, why the incremental costs differ in requirements (a) and (b).