March 13, 2016

Cost Behavior/Estimation, High-Low Method, Working Backward

1. Consider the graphs that follow (the horizontal axis represents activity; the vertical axis represents total dollars).

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Required:

For items A-I that follow, choose the graph that best represents the cost behavior pattern described. Note: Graphs can be used more than once.

A. Straight-line depreciation on machinery.

B. The cost of chartering a private airplane. The cost is \$800 per hour for the first 6 hours of a flight; it then drops to \$600 per hour.

C. The wages of table service personnel in a restaurant. The employees are part-time workers who can be called upon for as little as 4 hours at a time.

D. Weekly wages of store clerks who work 40 hours each week. One clerk is hired for every 125 sales made during the month.

E. The cost of tires used in the production of trucks.

F. Outbound shipping charges that increase at a decreasing rate as sales rise because the firm can use more efficient modes of transportation (e.g., full trailer loads, full rail cars, etc.). Gradually, however, at high levels of sales, freight costs start to increase at an increasing rate, which reflects more transactions made to customers in far-away locations.

G. Equipment leasing costs that are computed at \$2 per machine hour worked. The company pays a maximum of \$120,000 per month.

H. The monthly cost of a franchise fee for a fast-food restaurant. The franchisee must pay \$20,000 plus 5% of gross dollar sales.

I. The cost of electricity during peak demand periods, which is based on the following schedule:

Up to 20,000 kilowatt hours (KWH): \$4,000

Above 20,000 kilowatt hours: \$4,000 + \$0.02 per KWH

2. Resource Consulting is studying the costs of several clients, and has found that the accompanying graphs appear as follows:

1. A straight line that gradually slopes upward to the right

2. A curvilinear line that gradually slopes upward to the right

3. A straight line that is parallel to the graph’s horizontal axis

4. A straight line that gradually slopes downward to the right

5. A curvilinear line that gradually slopes downward to the right

6. A straight line that gradually slopes upward to the right and then, at a specific point, flattens out to run parallel to the horizontal axis

7. A series of straight lines that appear to resemble a set of steps

8. A straight line that runs parallel to the graph’s horizontal axis and then, at a specific point, drops to a lower level

Unless told otherwise, assume that the horizontal axis represents total activity and the vertical axis represents total cost.

Required:

For items A-F, indicate the number of the graph that best represents the cost behavior pattern described. Note: Graphs can be used more than once, and not all graphs need be used.

A. The salary cost of lab technicians employed at a clinic. One technician is needed for every 1,500 patients serviced.

B. The cost of glass used by a manufacturer of automobile windshields.

C. A profit-sharing bonus that is paid to the associate director of a firm that conducts professional-development courses for executives. The bonus is based on revenues from courses that are being run, subject to a maximum amount each year.

D. Flood insurance premiums that are paid by Reliable Manufacturing, which operates a production facility close to a river.

E. The paper cost that is used in the production of a textbook. Note: Assume that for this part only, the graph’s vertical axis represents the cost per unit rather than total cost.

F. Tariffs that are paid on products shipped overseas. For one particular country, if fewer than 15,000 units are shipped, the client must pay \$4 per unit. The tariff is raised by \$1 according to the following schedule:

15,000 to 29,999 units \$5 per unit

30,000 to 44,999 units \$6 per unit

45,000 to 59,999 units \$7 per unit

3. Consider the six costs that follow.

1. Advertising and promotion costs of a do-it-yourself retailer

2. Surgical supplies used in a hospital’s operating room

3. Aircraft depreciation charges of an airline

4. Utility charges that include a minimum-use fee, for a small business

5. Annual business licensing fee paid by a daycare center

6. Truck fuel consumed by a road construction company

Required:

A. Classify each of these costs as variable, committed fixed, discretionary fixed, or semivariable.

B. Briefly describe the behavior of a per-unit variable cost as activity changes.

C. What elements are present in a semivariable cost that cause it to behave in a semivariable manner?

D. Generally speaking, does management have more flexibility when dealing with committed fixed costs or discretionary fixed costs?

4. Sunshine Valley Meat Company produces one of the best sausage products in Pennsylvania. The company’s controller compiled the following information by analyzing the accounting records:

1. Meat costs the company \$3.25 per pound of sausage produced.

2. Compensation of production employees is \$2.25 per pound of sausage produced.

3. Supervisory salaries total \$23,000 per month.

4. The company incurs utility costs of \$9,000 per month plus \$0.35 per pound of sausage produced.

5. Insurance and property taxes average \$6,400 per month.

Required:

A. Classify each cost as variable, fixed, or semivariable.

B. Write a formula to express the behavior of the firm’s production costs. (Use the form Y = a + bX, where X denotes the quantity of sausage produced.)

5. Viscount Corporation has a machining capacity of 200,000 hours per year. Utilization of capacity is normally 75%; it has been as low as 40% and as high as 90%. An analysis of the accounting records revealed the following selected costs:

At a 40%

Utilization Rate

At a 90%

Utilization Rate

Cost A:

Total

\$440,000

\$ 440,000

Per hour

\$5.50

?

Cost B:

Total

?

\$1,944,000

Per hour

\$10.80

\$10.80

Cost C:

Total

\$680,000

\$1,330,000

Per hour

\$8.50

\$7.39

Viscount uses the high-low method to analyze cost behavior.

Required:

A. Classify each of the costs as being either variable, fixed, or semivariable.

B. Calculate amounts for the two unknowns in the preceding table.

C. Calculate the total amount that Viscount would expect at a 75% utilization rate for Cost A, Cost B, and Cost C.

D. Develop an equation that Viscount can use to predict total cost for any level of hours within its range of operation.

6. Walnut Corporation operates a small medical lab in Kansas, one that conducts minor medical procedures (including blood tests and x-rays) for a number of doctors. The lab consumes various medical supplies and is staffed by two technicians, both of whom are paid a monthly salary. In addition, there is an on-site office manager who is also paid by the month.

Required:

A. If the lab’s patient count increases by, say, 15%, will the lab’s total operating costs increase by 15%? Explain.

B. Walnut is considering opening an additional lab in a new suburban medical building. What will likely happen to the lab’s level of fixed cost incurrence? Why?

C. What analysis methods would be available to the office manager and/or Walnut management if a close look at the lab’s cost behavior is desired?

7. The following selected data were taken from the accounting records of Shook Industrial Manufacturing:

Month

Machine

Hours

May

46,000

\$ 889,000

June

60,000

1,130,000

July

68,000

1,274,000

August

52,000

980,000

July’s costs consisted of machine supplies (\$170,000), property taxes (\$24,000), and plant maintenance (\$1,080,000). These costs exhibit the following respective behavior: variable, fixed, and semivariable.

Required:

A. Determine the machine supplies and property taxes for May.

B. By using the high-low method, analyze Shook’s plant maintenance cost and calculate the monthly fixed portion and the variable cost per machine hour.

Assume that present cost behavior patterns continue into future months. Estimate the total amount of manufacturing overhead the company can expect in September if 56,000 machine hours are worked

8. Moore Company needs to determine the variable utilities rate per direct machine hour in order to estimate cost for August. Relevant information is as follows.

Month

MachineHours Worked

Utilities

Cost

April

4,800

\$4,144

May

5,200

4,300

June

5,600

4,482

July

6,000

4,804

Moore anticipates producing 3,800 units in August, with each unit requiring 1.5 hours of machine time. The company uses the high-low method to analyze costs.

Required:

A. Calculate the variable and fixed components of the utilities cost.

B. Using the data calculated above, estimate the utilities cost for August.

C. Compare the high-low method versus the visual-fit method with respect to (1) number of data observations used in the analysis and (2) objectivity of the results.

9. The Southlake Medical Clinic offers a number of specialized medical services. A review of data for the year just ended revealed variable costs of \$32 per patient day, annual fixed costs of \$480,000, and semivariable costs, which displayed the following behavior at the “peak” and “valley” of activity:

January (2,400 patient days): \$258,400

August (2,900 patient days): \$278,900

Required:

A. Calculate the total cost for an upcoming month (2,800 patient days) if current cost behavior patterns continue. Southlake uses the high-low method to analyze cost behavior.

B. There is a high probability that Southlake’s volume will increase in forthcoming months as patients take advantage of new scientific advances. Can the data and methodology used in part (a) for predicting the costs of 2,800 patient days be employed to estimate the costs for, say, 3,800 patient days? Why or why not?

C.

10. A-1 Corporation extracts ore for eight different companies in Colorado. The firm anticipates variable costs of \$65 per ton along with annual fixed overhead of \$840,000, which is incurred evenly throughout the year. These costs exclude the following semivariable costs, which are expected to total the amounts shown for the high and low points of ore extraction activity:

March (850 tons): \$39,900

August (1,300 tons): \$46,200

A-1 uses the high-low method to analyze cost behavior.

Required:

A. Calculate the semivariable cost for an upcoming month when 875 tons will be extracted.

B. Calculate the total cost for that same month.

C. A-1 uses Cortez Trucking to haul extracted ore. Cortez’s monthly charges are as follows:

800 – 1,099 tons

\$ 70,000

1,100 tons – 1,399 tons

90,000

1,400+ tons

110,000

1. From a cost behavior perspective, what type of cost is this?

2. If A-1 plans to extract 875 tons, is the company being very “cost effective” with respect to Cortez’s billing rates? Briefly discuss.

11. Charger Corporation has three costs: A, which is variable; B, which is fixed; and C, which is semivariable. The company, which uses the high-low method, extracted the following data from its accounting records:

· At 180,000 hours of activity, Cost A totaled \$2,610,000.

· At 140,000 hours, the low point during the period, Cost C totaled \$1,498,000; at 200,000 hours, the high point, Cost C’s fixed portion amounted to \$1.75 per hour.

· At 160,000 hours of activity, the sum of Costs A, B, and C amounted to \$8,162,000.

Required:

A. Compute the variable portion (total) of Cost C at 140,000 hours of activity.

B. Compute Cost C (total) at 160,000 hours of activity.

C. Compute Cost B (total) at 160,000 hours of activity.

12. Managers in the Stamping Department have been studying overhead cost and the relationship with machine hours. Data from the most recent 12 months follow.

Month

Machine Hours

January

\$5,030

2,730

February

1,600

600

March

7,210

3,403

April

4,560

2,200

May

6,880

3,411

June

6,520

2,586

July

6,230

3,364

August

5,570

2,411

September

7,728

3,960

October

5,810

2,897

November

4,580

2,207

December

6,010

2,864

The manager of the department has requested a regression analysis of these two variables (labeled no. 1 below). However, the staff person performing the analysis decided to run another regression that excluded February (labeled no. 2). She observed that the volume of activity was very low for that month because of two factors: a severe flu outbreak and an electrical fire that disrupted operations for about 10 working days.

Regression No. 1

Regression No. 2

Constant

428.00

Constant

550.00

0.79

0.74

b coefficient

1.86

b coefficient

1.90

Required:

A. Prepare an overhead cost breakdown by using the high-low method. The analysis should be useful in helping to predict variable and fixed costs under normal operating conditions.

B. Prepare an estimate of overhead cost for a volume of 3,000 machine hours by using regression no. 1.

C. You now have the ability to analyze three cost estimates from the high-low data in part (a) and the two regression equations. Which one do you feel would provide the best estimate? Explain the factors that support your choice. Note: Do not calculate an overhead cost estimate with regression no. 2.

13.Shortly after being hired as an analyst with Harrison Rentals, which is located in upstate New York, Luis Gomez was asked to prepare a report that focused on the company’s order processing costs—a cost driven largely by the number of rental invoices written. Luis knew that he could use several different tools to analyze cost behavior, including scatter diagrams, least-squares regression, and the high-low method. In addition, he knew that he could present the results of his analysis in the form of algebraic equations. Those equations follow.

Scatter diagram: OP = \$56,000 + \$6.80RI

Least-squares regression: OP = \$59,000 + \$6.75RI

High-low method: OP = \$53,500 + \$7.25RI

where OP = total order processing costs and RI = number of rental invoices written

Luis had analyzed data over the past 12 months and built equations based on these data, purposely including the slowest month of the year and the busiest month so that things would “…tend to even out.” He observed that February was especially slow because of a paralyzing blizzard, one that forced the company to close for four days.

Required:

A. Will scatter diagrams, least-squares regression, and the high-low method normally result in the same equation? Why?

B. Assuming the use of least-squares regression, explain what the \$59,000 and \$6.75 figures represent.

C. Assuming the use of a scatter diagram, predict the order processing cost of an upcoming month when Harrison expects to write 2,500 rental invoices.

D. Did Luis err in constructing the equations on data of the past 12 months? Briefly discuss. If “yes,” determine which of the three tools is likely to be affected the most and explain why.

14. North Company is making plans for the introduction of a new product, which has a target selling price of \$7 per unit. The following estimates of manufacturing costs have been derived for 6 million units, to be produced during the first year:

Direct material: \$6,000,000

Direct labor: \$2,100,000 (at \$14 per hour)

Overhead costs have not yet been estimated, but monthly data on total production and overhead for the past 12 months have been analyzed by using least-squares regression. The major overhead cost driver is direct labor hours, with the following results:

Computed values:

Coefficient of independent variable: \$2.25

Required:

A. Prepare the company’s regression equation (Y = a + bX) to estimate overhead.

B. Calculate the predicted overhead cost at an activity level of 6,300,000 units.

C. What is North’s dependent variable in this case?

D. How can the company evaluate the “quality” of its regression equation?

15. Compare and contrast the following types of costs: (1) variable and step-variable and (2) fixed and step-fixed.

16.Define the term “relevant range” and explain its importance in understanding cost behavior.

17. Differentiate between committed costs and discretionary costs. Be sure to present two examples of each and explain which of the two cost types would likely be cut should a company encounter financial difficulties.

18. Both the visual-fit and high-low methods of cost estimation have inherent limitations. Briefly identify the major deficiency associated with each method.

19. Distinguish between least-squares regression and multiple regression as cost estimation methods.

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