CHAPTER 6

Activity Analysis, Cost Behavior, and Cost

Estimation
ANSWERS TO REVIEW QUESTIONS
6-1

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.

6-2

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.

6-3

a. Hotel: Percentage of rooms occupied or the number of occupancy-days, where

an occupancy-day is defined as one room occupied for one day.
b. Hospital: Patient-days, where a patient-day is defined as a one-day stay by one
patient.
c. Computer manufacturer: Number of computers manufactured, throughput,
engineering specifications, engineering change orders, or number of parts in the
finished product.
d. Computer sales store: Sales revenue.
e. Computer repair service: Repair calls or hours of repair service.
f. Public accounting firm: Hours of auditing service provided by each classification
of personnel (partner, manager, supervisor, senior accountant, and staff
accountant).

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6.4

Graphs of the cost behavior patterns are as follows:

Cost

Cost

Activity

Activity

a. Variable

b. Step-variable

Cost

Cost

Cost

c. Fixed

e. Semivariable
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Activity
Cost

Activity

d. Step-fixed

Activity

Activity
f. Curvilinear
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6-5

As the level of activity (or cost driver) increases, total fixed cost remains constant.
However, the fixed cost per unit of activity declines as activity increases.

6-6

A manufacturer's cost of supervising production might be a step-fixed cost, because

one supervisor is needed for each shift. Each shift can accommodate a certain range
of production activity; when activity exceeds that range, a new shift must be added.
When the new shift is added, a new production supervisor must be employed. This
new position results in a jump in the step-fixed cost to a higher level.

6-7

As the level of activity (or cost driver) increases, total variable cost increases
proportionately and the variable cost per unit remains constant.

6-8

a. A semivariable cost behavior pattern can be used to approximate a step-variable

cost as shown in the following graph:
Cost
Semivariable
approximation

Step-variable
cost
Activity
b. A semivariable cost behavior pattern can be used to approximate a
curvilinear cost as shown in the following graph:
Cost

Curvilinear
cost

Semivariable
approximation
Activity
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6-9

(a) Annual cost of maintaining an interstate highway: committed cost. (Once the
highway has been built, it must be maintained. The transportation authorities are
largely committed to spending the necessary funds to maintain the highway
adequately.)
(b) Ingredients in a breakfast cereal: engineered cost.
(c) Advertising for a credit card company: discretionary cost.
(d) Depreciation on an insurance company's computer: committed cost.
(e) Charitable donations: discretionary cost.
(f) Research and development: discretionary cost.

6-10

The cost analyst should respond by pointing out that in most cases a cost behavior
pattern should be limited to the relevant range of activity. When the firm's 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. Within the relevant range, the firm's
utility cost can be approximated reasonably closely by a semivariable cost behavior
pattern. However, outside that range (including an activity level of zero), the
semivariable cost behavior pattern should not be used as an approximation of the
utility cost.

6-11

A learning curve shows how average labor time per unit of production changes as
cumulative output changes. In many production processes, as production activity
increases and learning takes place, there is a significant reduction in the amount of
labor time required per unit. The 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.

6-12

Appropriate independent variables for several tasks are as follows:

a. Handling materials at a loading dock: Weight of materials handled.
b. Registering vehicles at a county motor vehicle office: Number of registrations
processed.
c. Picking oranges: Volume or weight of oranges picked.
d. Inspecting computer components in an electronics firm: Number of components
inspected.

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6-13

An outlier is a data point that falls far away from the other points in the scatter
diagram and is not representative of the data. One possible cause of an outlier is
simply a mistake in recording the data. Another 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. Outliers should be eliminated from a data set
upon which cost estimates are based.

6-14

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. As a result, such costs may appear to be variable in the cost records.
Discretionary costs often are budgeted in a manner that makes them appear variable.
A cost such as charitable donations, for example, may be fixed once management
decides on the level of donations to be made. If management's policy is to budget
charitable donations on the basis of sales dollars, however, the cost will appear to be
variable to the cost analyst. An experienced analyst should be wary of allocated and
discretionary costs and take steps to learn how the amounts are determined.

6-15

In the first step of the visual-fit method of cost estimation, data points are plotted on
graph paper to form a scatter diagram. Then a line is drawn through the scatter
diagram in an attempt to minimize the distance between the line and the plotted
points. The 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. The method is easy to use and to explain to others and provides a useful
view of the overall cost behavior pattern. The visual-fit method also enables an
experienced cost analyst to spot outliers in the data. The primary drawback of the
visual-fit method is its lack of objectivity. Two cost analysts may draw two different
visually-fitted cost lines.

6-16

The chief drawback of the high-low method of cost estimation is that it uses only two
data points. The rest of the data are ignored by the method. An 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. In 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.

6-17

The term least squares in the least-squares regression method of cost estimation
refers to the process of minimizing the sum of the squares of the vertical distances
between the data and the regression line.

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6- 5

6-18

A least-squares regression line may be expressed in equation form as follows:

Y = a + bX
In this equation, 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. The intercept of the line on the
vertical axis is denoted by a, and the slope of the line is denoted by b. Within 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.

6-19

In simple regression there is a single independent variable. In multiple regression

there are two or more independent variables.

6-20

Potential cost drivers in the cruise industry include the following: number of
passengers, number of passenger miles traveled, number of port calls, cruise ship
tonnage (i.e., ship size), and number of crew members, among others.

6-21

A particular least-squares regression line may be evaluated on the basis of

economic plausibility or goodness of fit.
The cost analyst should always evaluate a regression line from the perspective of
economic plausibility. Does the regression line make economic sense? Is it
intuitively plausible? An experienced cost analyst should have a good feel for
whether the regression line looks reasonable.
Statistical methods can also be used to determine how well a regression line fits
the data upon which it is based. This method is referred to as assessing the
goodness of fit of the regression. A commonly used measure of goodness of fit is
the coefficient of determination, which is described in the appendix at the end of the
chapter. The coefficient of determination is also denoted by R2.

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SOLUTIONS TO EXERCISES
EXERCISE 6-22 (15 MINUTES)
1.
Cost Item
Production crew:
$5,330/410 hr.............................................
$8,840/680 hr.............................................
Supervisory employees:
$6,000/410 hr.............................................
$6,000/680 hr.............................................

Cost per Broadcast Hour

August
October
$13.00 per hr.
$13.00 per hr.
$14.63 per hr.*
$ 8.82 per hr.*

*Rounded.
2.

December cost predictions:

Production crew (440 $13.00 per hr.)..............................................
Supervisory employees......................................................................

$5,720
6,000

3.
Cost Item
Production crew........................................................
Supervisory employees ($6,000/440 hr.)..................

Cost per Broadcast Hour

in December
$13.00 per hr.
13.64 per hr.*

*Rounded.

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6- 7

EXERCISE 6-23 (40 MINUTES)

1.

Cost of food:

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EXERCISE 6-23 (CONTINUED)

2.

Cost of salaries and fringe benefits for administrative staff:

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EXERCISE 6-23 (CONTINUED)

3.

Laboratory costs:

Cost per month

$80,000
Total cost
$70,000

$60,000

$50,000

$40,000

$30,000

$20,000

$10,000

1,000

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2,000

Patient days

3,000

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EXERCISE 6-23 (CONTINUED)

4.

Cost of utilities:

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EXERCISE 6-23 (CONTINUED)

5.

Nursing costs:

Cost per month

$17,500
$15,000
Total cost

$12,500
$10,000
$7,500
$5,000
$2,500
200

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400

600

800

1,000

Patient days

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EXERCISE 6-24 (15 MINUTES)

1.

2.

a.

Fixed

b.

Variable

c.

Variable

d.

Fixed

e.

Semivariable (or mixed)

Production cost per month = $37,000* + $2.30X

*37,000 = $21,000 + $11,000 + $5,000

$2.30 = $1.20 + $.85 + $.25

EXERCISE 6-25 (15 MINUTES)

1.

Variable maintenance
cost per tour mile

= (18,750r-16,500r) / (30,000 miles 12,000 miles)

= .125r

r denotes the real, Brazils national currency.

Total maintenance cost at 12,000 miles......................................................
Variable maintenance cost at 12,000 miles (.125r 12,000).....................
Fixed maintenance cost per month............................................................
2.

16,500r
1,500r
15,000r

Cost formula:
Total maintenance cost per month = 15,000r + .125rX , where X denotes tour miles
traveled during the month.

3.

Cost prediction at the 34,000-mile activity level:

Maintenance cost

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15,000r + (.125r)(34,000)

19,250r

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EXERCISE 6-25 (CONTINUED)

2.

THE ELECTRONIC VERSION OF THE SOLUTIONS MANUAL

BUILD A SPREADSHEET SOLUTIONS IS AVAILABLE ON YOUR
INSTRUCTORS CD AND ON THE HILTON, 8E WEBSITE:
WWW.MHHE.COM/HILTON8E.

EXERCISE 6-26 (15 MINUTES)

1.

2.

Actual
$1,950
2,600
3,000
4,250

Estimated
$2,200
2,600
3,000
3,600

a.
b.
c.
d.

20,000 miles..................................................................
40,000 miles..................................................................
60,000 miles..................................................................
90,000 miles..................................................................

(a)

The approximation is very accurate in the range 40,000 to 60,000 miles per
month.

(b)

The approximation is less accurate in the extremes of the longer range, 20,000 to
90,000 miles.

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EXERCISE 6-27 (30 MINUTES)

1.

Scatter diagram and visually-fitted line:

Cost of diagnostic testing

$50,000

$40,000

$30,000

$20,000

$10,000

500

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1,000

1,500

2,000

2,500

3,000

3,500

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Tests

EXERCISE 6-27 (CONTINUED)

2.

The requirement asks for an estimate based on the visually-fit cost line. Therefore,
answers will vary on this requirement because of variation in the visually-fitted lines.
Based on the preceding plot:
Monthly fixed cost.............................................................................................
Variable cost per diagnostic test.....................................................................

$14,000
$ 10.56*

*Calculation of variable cost:

Total cost at
Total cost at
Difference:

3,600
0
3,600

tests...........................................
tests...........................................
tests...........................................

Variable cost per diagnostic test

$52,000
14,000
$38,000

$38,000
3,600

= $10.56

Rounded.

EXERCISE 6-28 (30 MINUTES)

Answers will vary widely, depending on the company and costs selected. Some examples
of typical manufacturing costs follow.
Direct material: variable
Electricity: variable
Depreciation on plant and equipment: fixed
Plant managers salary: fixed
Property taxes: fixed

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EXERCISE 6-29 (15 MINUTES)

1.

Variable cost per pint of applesauce produced =

$72,300 $66,300
$.10
123,000 63,000

Total cost at 123,000 pints.........................................................................

Variable cost at 123,000 pints
(123,000 $.10 per pint)...................................................................
Fixed cost....................................................................................................

$72,300
12,300
$60,000

Cost equation:
Total energy cost = $60,000 + $.10X, where X denotes pints of applesauce produced
2.

Cost prediction when 78,000 pints of applesauce are produced

Energy cost = $60,000 + ($.10)(78,000) = $67,800

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EXERCISE 6-30 (30 MINUTES)

1.

Scatter diagram and visually-fitted line:

Monthly energy cost

$90,000

$75,000

$60,000

$45,000

$30,000

$15,000

30,000

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60,000

90,000

120,000

150,000

Pints of applesauce produced

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EXERCISE 6-30 (CONTINUED)

2.

Answers will vary on this requirement because of variation in the visually-fitted lines.
Based on the preceding plot, the cost prediction at 78,000 pounds is:
Energy cost = $67,800

3.

The July cost observation at the 120,000-pint activity level appears to be an outlier.
The cost analyst should check the observation data for accuracy. If the data are
accurate, the outlier should be ignored in making cost predictions.

EXERCISE 6-31 (10 MINUTES)

1.

(a)
(b)

Average time for 4 satellites..............................................................

Average time for 8 satellites..............................................................

195 hours
150 hours

2.

(a)
(b)

Total time for 4 satellites (195 hr. X 4)..............................................

Total time for 8 satellites (150 hr. X 8)..............................................

780 hours
1,200 hours

3.

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

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EXERCISE 6-32 (15 MINUTES)

Monthly audit cost

$100,000
Total cost when 100 audits are performed
in a month: $78,200 = $10,000 + ($682) (100)
$80,000

$60,000

$40,000

$20,000

Fixed cost per month: $10,000

20

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40

60

80

100

Tax
returns
audited

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EXERCISE 6-33 (45 MINUTES)

1.

Variable utility cost per hour

$3,800 $2,600
=
700 400

$4.00

Total utility cost at 700 hours......................................................................

Variable utility cost at 700 hours ($4.00 700 hours)...............................
Fixed cost per month...................................................................................

$ 3,800
2,800
$ 1,000

Cost formula:
Monthly utility cost = $1,000 + $4.00 X , where X denotes hours of operation.
2.

Variable-cost estimate based on the scatter diagram on the next page:

Cost at
Cost at
Difference

600 hours .......................................................................

0 hours .......................................................................
600 hours .......................................................................

$3,400
900
$2,500

Variable cost per hour = $2,500/600 hr. = $4.17 (rounded)

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EXERCISE 6-33 (CONTINUED)

Scatter diagram and visually-fit line:
Utility cost
per month

Hours of
operation

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EXERCISE 6-33 (CONTINUED)

3.

Estimation of variable- and fixed-cost components of cost behavior using leastsquares regression:
The electronic version of the Solutions Manual BUILD A SPREADSHEET
SOLUTIONS is available on your Instructors CD and on the Hilton, 8e website:
www.mhhe.com/hilton8e.

4.

Cost predictions at 300 hours of operation:

(a)

High-low method:
Utility cost

(b)

$1,000 + ($4.00)(300) = $2,200

Visually-fitted line:
Utility cost

= $2,190

This cost prediction was simply read directly from the visually-fitted cost line.
This prediction will vary because of variations in the visually-fitted lines.
(c)

Regression:
Utility cost = $1,002 + ($4.04)(300) = $2,214

5.

Calculation of R2:
The electronic version of the Solutions Manual BUILD A SPREADSHEET
SOLUTIONS is available on your Instructors CD and on the Hilton, 8e website:
WWW.MHHE.COM/HILTON8E.
The R2 is .9518.

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EXERCISE 6-33 (CONTINUED)

The following alternative approach to calculating the regression parameters is not a
requirement in the problem.
Least-square regression using manual calculations:
(a)

Tabulation of data:
Dependent
Variable
(cost)
Y
3,240
3,400
3,800
3,200
2,700
2,600
18,940

Month
January.......................
February......................
March..........................
April.............................
May..............................
June............................
Total............................

Independent
Variable
(hours)
X
550
600
700
500
450
400
3,200

X2
302,500
360,000
490,000
250,000
202,500
160,000
1,765,000

XY
1,782,000
2,040,000
2,660,000
1,600,000
1,215,000
1,040,000
10,337,000

(b) Calculation of parameters:

( Y )( X 2 ) ( X )( XY )
a =
n( X 2 ) ( X )( X )

= (18,940)(1,765,000) (3,200)(10,337,000) 1,002

(6)(1,765,000) (3,200)(3,200)

b = n( XY) ( X)( Y)
n( X 2 ) ( X)( X)
=
(c)

(6)(10,337,000) (3,200)(18,940)
4.04
(6)(1,765,000) (3,200)(3,200)

Cost formula:
Monthly utility cost

= $1,002 + $4.04X, where X denotes hours of operation.

Variable utility cost

= $4.04 per hour of operation

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EXERCISE 6-34 (45 MINUTES)

1.

The electronic version of the Solutions Manual BUILD A SPREADSHEET

SOLUTIONS is available on your Instructors CD and on the Hilton, 8e website:
www.mhhe.com/hilton8e.

2.

The electronic version of the Solutions Manual BUILD A SPREADSHEET

SOLUTIONS is available on your Instructors CD and on the Hilton, 8e website:
www.mhhe.com/hilton8e.

The following alternative approach to calculating the regression parameters and R 2 is not a
requirement in the problem.
Least-square regression using manual calculations:
(a)

Tabulation of data:

Month
July..............................
August........................
September..................
October.......................
November...................
December....................
Total............................

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Dependent
Variable
(cost in
thousands)
Y
54
54
57
60
54
57
336

Independent
Variable
(thousands
of
passengers)
X
16
17
16
18
15
17
99

X2
256
289
256
324
225
289
1,639

XY
864
918
912
1,080
810
969
5,553

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EXERCISE 6-34 (CONTINUED)

(b) Calculation of parameters:
( Y )( X 2 ) ( X )( XY )
a =
n( X 2 ) ( X )( X )

=
b =
=
(c)

(336)(1,639) (99)(5,553)
29 (rounded)
(6)(1,639) (99)(99)

n( XY) ( X)( Y)
n( X 2 ) ( X)( X)
(6)(5,553) (99)(336)
1.636 (rounded)
(6)(1,639) (99)(99)

Cost formula:
Monthly cost of flight service = $29,000 + $1,636X, where X denotes thousands of
passengers.

Calculation and interpretation of R2 using manual calculations:

(a)

Formula for calculation:

R 2 1

where

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(Y Y ') 2
(Y Y ) 2

denotes the observed value of the dependent variable (cost) at a

particular activity level.

Y'

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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EXERCISE 6-34 (CONTINUED)

(b)

Tabulation of data:*

Month
July.................
August............
September.....
October..........
November......
December.......
Total................
*Y'
Y

Y
54
54
57
60
54
57

X
16
17
16
18
15
17

Predicted Cost (in

thousands)
Based on
Regression
Line Y'
[( Y Y')2]
55.176
1.383
56.812
7.907
55.176
3.327
58.448
2.409
53.540
.212
56.812
.035
15.273

[(Y Y )2]
4.000
4.000
1.000
16.000
4.000
1.000
30.000

= ($29,000 + $1,636X)/$1,000
=
Y/6 = 56

Rounded.

(c)

Calculation of R2:
R2 = 1

(d)

15.273
= .49 (rounded)
30.000

Interpretation of R2:
The coefficient of determination, R2, is a measure of the goodness of fit of the
least-squares regression line. An R2 of .49 means that 49% of the variability of
the dependent variable about its mean is explained by the variability of the
independent variable about its mean. The higher the R2, the better the regression
line fits the data. The interpretation of a high R2 is that the independent variable
is a good predictor of the behavior of the dependent variable. In cost estimation,
a high R2 means that the cost analyst can be relatively confident in the cost
predictions based on the estimated-cost behavior pattern.

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SOLUTIONS TO PROBLEMS
PROBLEM 6-35 (20 MINUTES)
1.

5.

9.

2.

6.

10. k

3.

7.

11. l

4.

8.

Note that j was not used.

PROBLEM 6-36 (15 MINUTES)
An appropriate activity measure for the school would be hours of instruction. The costs are
classified as follows:
1.

Variable

6.

Variable

2.

Semivariable (or mixed)*

7.

Fixed

3.

Fixed

8.

Fixed

4.

Fixed

9.

Semivariable (or mixed)

5.

Fixed

*The fixed-cost component is the salary of the school's repair technician. As activity
increases, one would expect more repairs beyond the technician's capability. This increase
in repairs would result in a variable-cost component equal to the dealer's repair charges.

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PROBLEM 6-37 (25 MINUTES)

1.

Variable maintenance cost per hour of service

$4,710 $2,990

525 310

= $8.00
Total maintenance cost at 310 hours of service........................................
Variable maintenance cost at 310 hours of service (310 hr. $8.00).......
Fixed maintenance cost per month............................................................

$2,990
2,480
$ 510

Cost formula:
Monthly maintenance cost = $510 + $8.00X, where X denotes hours of
maintenance service.
2.

The variable component of the maintenance cost is $8.00 per hour of

service.

3.

Cost prediction at 600 hours of activity:

Maintenance cost = $510 + ($8.00)(600) = $5,310

4.

Variable cost per hour [from requirement (2)]...........................................

Fixed cost per hour at 610 hours of activity ($510/610)............................

$8.00
$ .84*

*Rounded.
The fixed cost per hour is a misleading amount, because it will change
as the number of hours changes. For example, at 500 hours of
maintenance service, the fixed cost per hour is $1.02 ($510/500 hours).

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PROBLEM 6-38 (25 MINUTES)

1.

Straight-line depreciationcommitted fixed

Charitable contributionsdiscretionary fixed
Mining labor/fringe benefitsvariable
Royaltiessemivariable
Trucking and haulingstep-fixed
The per-ton mining labor/fringe benefit cost is constant at both volume levels
presented, which is characteristic of a variable cost.
$315,000 1,400 tons = $225 per ton
$607,500 2,700 tons = $225 per ton
Royalties have both a variable and a fixed component, making it a semivariable
(mixed) cost.
Variable royalty cost = difference in cost difference in tons
= ($224,500 $140,000) (2,700 1,400)
= $84,500 1,300 tons
= $65 per ton
Fixed royalty cost:

Total royalty cost.

Less: Variable cost at $65 per ton..
Fixed royalty cost
2.

June
(2,700 tons)

December
(1,400 tons)

$224,500
175,500
$ 49,000

$140,000
91,000
$ 49,000

Total cost for 1,700 tons:

Depreciation... $ 30,000
Charitable contributions.
---Mining labor/fringe benefits at $225 per ton.
382,500
Royalties:
Variable at $65 per ton..
110,500
Fixed..
49,000
Trucking and hauling..
280,000
Total.. $852,000

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PROBLEM 6-38 (CONTINUED)

3.

Hauling 1,400 tons is not particularly cost effective. Lone Mountain Extraction will
incur a cost of $280,000 if it needs 1,400 tons hauled or, for that matter, 1,899 tons.
The company would be better off if it had 1,399 tons hauled, saving outlays of
$40,000. In general, with this type of cost function, effectiveness is maximized if a
firm operates on the right-most portion of a step, just prior to a jump in cost.

4.

A committed fixed cost results from an entitys ownership or use of facilities and its
basic organizational structure. Examples of such costs include property taxes,
depreciation, rent, and management salaries. Discretionary fixed costs, on the other
hand, arise from a decision to spend a particular amount of money for a specific
purpose. Outlays for research and development, advertising, and charitable
contributions fall in this category.
In times of severe economic difficulties, a companys management will often
try to cut discretionary fixed costs. Such costs are more easily altered in the short
run and do not have as significant long-term ramifications for a firm as do more
long-lasting actions. While its true that cutting expenditures on advertising or R & D
can often have adverse long-term consequences, other cuts could have even more
significant negative consequences in the future. The decision to close a
manufacturing facility, for example, could reduce property taxes, rent, and/or
depreciation. However, that decision may result in a significant long-run change in
operations that may be difficult to overturn when economic conditions rebound.

5.

Lone Mountain Extraction uses a calendar year for tax-reporting purposes. At yearend, it may have ample funds available and decide to make donations to charitable
causes. Such contributions are deductible in computing the companys tax
obligation to the government. Tax deductions reduce taxable income and, therefore,
produce a tax savings for the firm.

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PROBLEM 6-39 (25 MINUTES)

1.

Machine supplies: $153,000 34,000 direct-labor hours = $4.50 per hour

So for April we have: 23,000 direct-labor hours x $4.50 = $103,500
Depreciation: Fixed at $22,500

2.

Plant maintenance cost:

Total cost*..
Less: Machine supplies.
Depreciation..
Plant maintenance...

April

June

(23,000
hours)

(34,000
hours)

$ 681,000
(103,500)
(22,500)
$ 555,000

$ 879,000
(153,000)
(22,500)
$ 703,500

* Excludes supervisory labor cost

Variable maintenance cost = difference in cost difference in direct-labor hours
= ($703,500 $555,000) (34,000 23,000)
= $148,500 11,000 hours
= $13.50 per hour
Fixed maintenance cost:

Total maintenance cost.............................

Less: Variable cost at $13.50 per hour....
Fixed maintenance cost............................

McGraw-Hill/Irwin
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April
(23,000
hours)

June
(34,000
hours)

$555,000
310,500
$244,500

$703,500
459,000
$244,500

2009 The McGraw-Hill Companies,

Solutions Manual

PROBLEM 6-39 (CONTINUED)

3.

Manufacturing overhead at 29,500 labor hours:

Machine supplies at $4.50 per hour...............
Depreciation.....................................................
Plant maintenance cost:
Variable at $13.50 per hour.......................
Fixed...........................................................
Supervisory labor............................................
Total.....................................................

$132,750
22,500
398,250
244,500
135,000
$933,000

4.

A fixed cost remains constant when a change occurs in the cost driver (or activity
base). A step-fixed cost, on the other hand, remains constant within a range but will
change (rise or fall) when activity falls outside that range. In other words, a fixed
cost is constant over a wider range of activity than a step-fixed cost.

5.

Ideally, the company should operate on the right-most portion of a step, just prior to
the jump in cost. In this manner, a firm receives maximum benefit (i.e., the maximum
amount of activity) for the dollars invested.

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PROBLEM 6-40 (40 MINUTES)

1.

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PROBLEM 6-40 (CONTINUED)

2.

See graph for requirement (1).

3.

The estimate of the fixed cost is the intercept on the vertical axis.
Fixed-cost component = $9,700
To estimate the variable-cost component, choose any two points on the visually-fitted
cost line. For example, choose the following points:
Activity
0..............................................................................................
2,000........................................................................................

Cost
$ 9,700
11,700

Then proceed as follows to estimate the variable-cost component:

Variable cost per unit of activity*

$11,700 $9,700
2,000 0

= $1.00
*Pounds (in hundreds) of equipment loaded or unloaded
4.

Cost equation:
Total material-handling cost = $9,700 + $1.00X, where X denotes the number pounds
(in hundreds) of equipment loaded or unloaded during the month.

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PROBLEM 6-40 (CONTINUED)

5.

High-low method:
$12,120 $10,200
2,600 1,000

Variable cost unit of activity* =

= $1.20
*Pounds (in hundreds) of equipment loaded or unloaded
Total cost at 2,600 units of activity...............................................................
Deduct: Variable cost at 2,600 units of activity (2,600 $1.20)..................
Fixed cost.......................................................................................................

$12,120
3,120
$ 9,000

Cost equation based on high-low method:

Material-handling cost per month = $9,000 + $1.20X, where X denotes the number of
units of activity during the month.

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PROBLEM 6-40 (CONTINUED)

6.

Memorandum
Date:

Today

To:

President, Nantucket Marine Supply

From:

I.M. Student

Subject: Material-handling cost estimates

On the basis of a scatter diagram and visually-fitted cost line, the Material-Handling
Department's monthly cost behavior was estimated as follows:
Material-handling cost per month = $9,700 + $1.00 unit of activity
A unit of activity is defined in this department as 100 pounds of equipment loaded or
unloaded at the loading dock.
Using the high-low method, the following cost estimate was obtained:
Material-handling cost per month = $9,000 + $1.20 unit of activity
The two methods yield different estimates because the high-low method uses only
two data points, ignoring the rest of the information. The method of visually fitting a
cost line, while subjective, uses all of the data available.
In 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.

Predicted Material-Handling Costs

Using Visually-Fit
Cost Line*
$11,950 = $9,700 + ($1.00)(2,250)

Using
High-Low Method
$11,700 = $9,000 + ($1.20)(2,250)

*This method is preferable, because it uses all of the data

in developing the cost equation.

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PROBLEM 6-41 (45 MINUTES)

1.

Estimation of variable and fixed components of cost behavior using least-squares

regression:
The electronic version of the Solutions Manual BUILD A SPREADSHEET
SOLUTIONS is available on your Instructors CD and on the Hilton, 8e website:
www.mhhe.com/hilton8e.

2.

Least-squares regression equation:

The electronic version of the Solutions Manual BUILD A SPREADSHEET
SOLUTIONS is available on your Instructors CD and on the Hilton, 8e website:
www.mhhe.com/hilton8e.
Total monthly cost = $9,943 + $.89 per unit of activity

3.

Cost prediction:
The electronic version of the Solutions Manual BUILD A SPREADSHEET
SOLUTIONS is available on your Instructors CD and on the Hilton, 8e website:
www.mhhe.com/hilton8e.

4.

The cost predictions differ because the cost formulas differ under the three costestimation methods. The high-low method, while objective, uses only two data points.
Ten observations are excluded.
The visual-fit method, while it uses all of the data, is somewhat subjective.
Different analysts may draw different cost lines.
Least-squares regression is objective, uses all of the data, and is a statistically
sound method of estimation.
Therefore, least-squares regression is the preferred method of cost estimation.
5.

Calculation of R2:
The electronic version of the Solutions Manual BUILD A SPREADSHEET
SOLUTIONS is available on your Instructors CD and on the Hilton, 8e website:
www.mhhe.com/hilton8e.

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The following alternative approach to calculating the regression parameters is not

a requirement in the problem.
Least-squares regression using manual calculations:
(a)

Tabulation of data:
Dependent
Variable
(cost in
thousands)
Y
11.70
11.30
11.25
10.20
11.10
12.55
12.00
11.40
12.12
11.05
11.35
11.35
137.37

Month
January.......................
February......................
March..........................
April.............................
May..............................
June............................
July..............................
August........................
September..................
October.......................
November...................
December....................
Total............................

Independent
Variable
(units of
activity in
thousands)
X
1.8
1.6
1.3
1.0
2.2
2.4
2.0
1.8
2.6
1.1
1.2
1.4
20.4

X2
3.24
2.56
1.69
1.00
4.84
5.76
4.00
3.24
6.76
1.21
1.44
1.96
37.70

XY
21.060
18.080
14.625
10.200
24.420
30.120
24.000
20.520
31.512
12.155
13.620
15.890
236.202

(b) Calculation of parameters:

( Y )( X 2 ) ( X )( XY )
a =
n( X 2 ) ( X )( X )

=
b =
=

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(137.37)(37.7) (20.4)(236.202)
9.943 (rounded)
(12)(37.7) (20.4)(20.4)

n( XY) ( X)( Y)
n( X 2 ) ( X)( X)
(12)(236.202) (20.4)(137.37)
.885 (rounded)
(12)(37.7) (20.4)(20.4)

2009 The McGraw-Hill Companies,

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PROBLEM 6-41 (CONTINUED)

(c)

Fixed- and variable-cost components:

Monthly fixed cost = $9,943*
Variable cost = $.89 per unit of activity (rounded)
*The intercept parameter (a) computed above is the cost per month in
thousands.

The slope parameter (b) calculated above is the cost in thousands of dollars per
thousand units of activity. Equivalently, it is the cost per unit of activity.

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PROBLEM 6-42 (40 MINUTES)

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PROBLEM 6-42 (CONTINUED)

3.

Fixed-cost component = $13,005

Variable-cost component:
Variable cost
=
per golfer

$13,205 $13,005
200 0

= $1
Cost equation:
Maintenance cost per month = $13,005 + $1X, where X denotes the number of golfers
during the month.
4.

Predicted Course Maintenance Costs

150 people tee off................................

158 people tee off................................

McGraw-Hill/Irwin
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Using Fixed
Cost Coupled
with StepVariable Cost
Behavior
Pattern
$13,150
13,160

Using
Semivariable Cost
Approximation
$13,155
13,163

2009 The McGraw-Hill Companies,

Solutions Manual

PROBLEM 6-43 (35 MINUTES)

1.

The regression equation's intercept on the vertical axis is $190. It represents the
portion of indirect material cost that does not vary with machine hours when
operating within the relevant range. The slope of the regression line is $5 per machine
hour. For every machine hour, $5 of indirect material costs are expected to be
incurred.

2.

Estimated cost of indirect material at 850 machine hours of activity:

S = $190 + ($5 850)
= $4,440

3.

Several questions should be asked:

(a)

Do the observations contain any outliers, or are they all representative of normal
operations?

(b)

Are there any mismatched time periods in the data? Are all of the indirect
material cost observations matched properly with the machine hour
observations?

(c)

Are there any allocated costs included in the indirect material cost data?

(d)

Are the cost data affected by inflation?

4.
Beginning inventory.............................................................
+ Purchases..........................................................................
Ending inventory...............................................................
Indirect material used..........................................................
5.

April
$1,300
5,900
(1,350)
$5,850

August
$1,000
6,200
(3,000)
$4,200

High-low method:
Variable cost per machine hour

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difference in cost levels

difference in activity levels

$5,850 $4,200 $1,650

$5.50 per machine hour

1,000 700
300

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PROBLEM 6-43 (CONTINUED)

Fixed cost per month:
Total cost at 1,000 hours...............................................................................
Variable cost at 1,000 hours
($5.50 1,000).........................................................................................
Fixed cost.......................................................................................................

$5,850
5,500
$ 350

Equation form:
Indirect material cost = $350 + ($5.50 machine hours)
6.

The regression estimate should be recommended because it uses all of the data, not
just two pairs of observations when developing the cost equation.

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PROBLEM 6-44 (25 MINUTES)

1.

Scatter diagrams:

Present, in graphic form, the relationship between costs and cost drivers via a plot of
data points
Require that a straight line be fit through the data points, with approximately the same
number of data points above and below the line
Easy to use
Provide a means to easily recognize outliers
Least-squares regression:
Uses statistical formulas to fit a cost line through the data points
Is a very objective method of cost estimation that uses all the data points
Requires more computation than other cost-estimation methods; however, software
programs are readily available
High-low method:
Relies on only two data points (for the highest and lowest activity levels) in drawing
conclusions about cost behavior
Is considered more objective than the scatter diagram; however, is weaker than the
scatter diagram because it relies on only two data points
The least-squares regression method will typically produce the most accurate
results.
2.

Yes. The three methods produce equations by different means. Scatter diagrams
and least-squares regression rely on an examination of all data points. The scatter
diagram, however, requires an analyst to fit a line through the points by visual
approximation, or eyeballing. In contrast, least-squares 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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PROBLEM 6-44 (CONTINUED)

3.

These amounts represent the fixed and variable costs associated with the ticketing
operation. Fixed cost totals $300,000 within the relevant range, and Florida
International incurs $2.25 of variable cost for each ticket issued.

4.

C = $295,000 + $2.20PT
C = $295,000 + ($2.20 x 570,000)
C = $1,549,000

5.

Yes, she did err by including November data. November is not representative
because of the effects of the Southeastern Airlines strike. The month is an outlier
and should be eliminated from the data set.

6.

Currently, most of the airlines tickets are written through reservations personnel,
whose wages are likely variable in nature. Heavier reliance on the Internet means a
greater investment in software, Web-site maintenance and development, and other
similar expenditures. Outlays that fall in these latter categories are typically fixed
costs, assuming that the cost driver is the number of tickets. The 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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PROBLEM 6-45 (40 MINUTES)

1.

The original method was simply the average overhead per hour for the last 12
months and did not distinguish between fixed and variable costs. Dana divided total
overhead by total labor hours, which effectively treated all overhead as variable.
Regression 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 2,500 to 7,500 labor hours.

2.

a. Based on the regression analysis, the variable cost per person for a cocktail
party is $23, calculated as follows:
Food and beverages...............................................................................
Labor (.6 hr. @ $11/hr.)...........................................................................
Variable overhead (.6 hr. @ $4/hr.).........................................................
Total...................................................................................................

$14.00
6.60
2.40
$23.00

b. Based on the regression analysis, the full absorption cost per person for a
cocktail party is $29, calculated as follows:
Food and beverages...............................................................................
Labor (.6 hr. @ $11/hr.)...........................................................................
Variable overhead (.6 hr. @ $4/hr.).........................................................
Fixed overhead (.6 hr. @ $10/hr.)*..........................................................
Total...................................................................................................

$14.00
6.60
2.40
6.00
$29.00

*$48,000 x 12 months = $576,000

$576,000/57,600 hr. = $10/hr.
3.

The minimum bid for a 250-person cocktail party would be $5,750. The amount is
calculated by multiplying the variable cost per person of $23 by 250 people. At any
price above the variable cost, Dana will be earning a contribution toward his fixed
costs.

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PROBLEM 6-45 (CONTINUED)

4.

Other factors that Dana should consider in developing a bid include the following:

The assessment of the current capacity of Danas business. If the business is at

capacity, other work would have to be sacrificed at some opportunity cost.
Analyses of the competition. If competition is rigorous, Dana may not have much
bargaining power.
A determination of whether or not Danas bid will set a precedent for lower prices.
The realization that regression analysis is based on historical data, and that any
anticipated changes in the cost structure should be considered.

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PROBLEM 6-46 (45 MINUTES)

1.
Scatter diagram:

Airport costs
$30,000

$25,000

$20,000

$15,000

$10,000

$5,000

250

500

750

1,000

1,250

1,500

1,750
Flights

Note: Only 11 data points appear, because two monthly observations were identical
(February and October).
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PROBLEM 6-46 (CONTINUED)

2.

Estimation of variable- and fixed-cost components of cost behavior using leastsquares regression:
The electronic version of the Solutions Manual BUILD A SPREADSHEET
SOLUTIONS is available on your Instructors CD and on the Hilton, 8e website:
www.mhhe.com/hilton8e.

3.

Cost equation:
The electronic version of the Solutions Manual BUILD A SPREADSHEET
SOLUTIONS is available on your Instructors CD and on the Hilton, 8e website:
www.mhhe.com/hilton8e.
Total monthly airport cost = $11,796 + $677X, where X denotes the number of flights

4.

Cost prediction for 1,500 flights:

The electronic version of the Solutions Manual BUILD A SPREADSHEET
SOLUTIONS is available on your Instructors CD and on the Hilton, 8e website:
www.mhhe.com/hilton8e.
5. Calculation of R2;
The electronic version of the Solutions Manual BUILD A SPREADSHEET
SOLUTIONS is available on your Instructors CD and on the Hilton, 8e website:
www.mhhe.com/hilton8e.
Interpretation of R2:
The coefficient of determination, R2, is a measure of the goodness of fit of the
least-squares regression line. An R2 of .58 means that 58% of the variability of
the dependent variable about its mean is explained by the variability of the
independent variable about its mean. The higher the R2, the better the regression
line fits the data. The interpretation of a high R2 is that the independent variable
is a good predictor of the behavior of the dependent variable. In the countys
cost estimation, a high R2 would mean that the county budget officer can be
relatively confident in the cost predictions based on the estimated-cost behavior
pattern. An R2 of .58 is not particularly high.

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PROBLEM 6-46 (CONTINUED)

The following alternative approach to calculating the regression parameters and R 2 is not a
requirement in the problem.
Least-squares regression using manual calculations:
(a)

Tabulation of data:
Dependent
Variable
(cost in
thousands)
Y
20
19
18
19
17
20
21
17
21
19
24
18
233

Month
January.......................
February......................
March..........................
April.............................
May..............................
June............................
July..............................
August........................
September..................
October.......................
November...................
December....................
Total............................

Independent
Variable
(flights in
hundreds)
X
12
10
9
14
8
11
15
9
12
10
14
11
135

X2
144
100
81
196
64
121
225
81
144
100
196
121
1,573

XY
240
190
162
266
136
220
315
153
252
190
336
198
2,658

(b) Calculation of parameters:

( Y )( X 2 ) ( X )( XY )
a =
n( X 2 ) ( X )( X )
=
b =

(233)(1,573) (135)(2,658)
11.796 (rounded)
(12)(1,573) (135)(135)

n( XY) ( X)( Y)
n( X 2 ) ( X)( X)
(12)(2,658) (135)(233)

= (12)(1,573) (135)(135) .677 (rounded)

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PROBLEM 6-46 (CONTINUED)

(c)

Fixed- and variable-cost components:

Monthly fixed cost = $11,796
Variable cost = $677 per hundred flights

Calculation and interpretation of R 2 using manual calculations

(a)

Formula for calculation:

R2 1

where

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(Y Y ') 2
(Y Y ) 2

denotes the observed value of the dependent variable (cost) at a

particular activity level.

Y'

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).

2009 The McGraw-Hill Companies,

Solutions Manual

PROBLEM 6-46 (CONTINUED)

(b)

Tabulation of data:*

Month
January..........
February.........
March.............
April................
May.................
June................
July.................
August............
September.....
October..........
November......
December.......
Total................
*Y'
Y

Y
20
19
18
19
17
20
21
17
21
19
24
18

X
12
10
9
14
8
11
15
9
12
10
14
11

Predicted Cost (in

thousands)
Based on
Regression
Line Y'
[( Y Y')2]
19.920
.006
18.566
.188
17.889
.012
21.274
5.171
17.212
.045
19.243
.573
21.951
.904
17.889
.790
19.920
1.166
18.566
.188
21.274
7.431
19.243
1.545
18.019

[(Y Y )2]
.340
.174
2.008
.174
5.842
.340
2.506
5.842
2.506
.174
21.004
2.008
42.918

= ($11,796 + $677X)/$1,000
=
Y/12 = 233/12 = 19.417 (rounded)

Rounded.

(c)

Calculation of R2:
R2 = 1

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18.019
= .58 (rounded)
42.918

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SOLUTIONS TO CASES
CASE 6-47 (45 MINUTES)
1.

Cairns' preliminary estimate for overhead of $18.00 per direct-labor hour does not
distinguish between fixed and variable overhead. This preliminary rate is applicable
only to the activity level at which it was computed (72,000 direct-labor hours per year)
and may not be used to predict total overhead at other activity levels.
The overhead rate developed from the least-squares regression recognizes the
relationship between cost and volume in the data. The regression suggests that there
is a component of the cost ($52,400 per month) that is unrelated to total direct-labor
hours. This 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. Thus, the least-squares regression results in a cost function with two
components: fixed cost per month and variable cost per direct-labor hour. This cost
formula can be used to predict total overhead at any activity level within the relevant
range.

2.

Direct material...............................................................................................
Direct labor (5 DLH* $11.00 per DLH).......................................................
Variable overhead (5 DLH $9.25 per DLH)...............................................
Total variable cost per 1,000 square feet....................................................

$390.00
55.00
46.25
$491.25

*DLH denotes direct-labor hours.

3.

The minimum bid should include the following incremental costs of the project.:
Direct material ($390.00 50)......................................................................
Direct labor ($55.00 50).............................................................................
Variable overhead ($9.25 per DLH 5 DLH 50).......................................
Overtime premium ($5.50 per DLH 5 DLH 50 .3)..............................
Minimum bid..................................................................................................

4.

$19,500.00
2,750.00
2,312.50
412.50
$24,975.00

Yes, Cairns can rely on the formula as long as she recognizes that there are some
shortcomings. The fact that least-squares regression estimates cost behavior
increases the usefulness of rates computed from cost data. However, the regression
is based on historical costs that may change in the future, and Cairns must assess
whether the cost equation would need to be revised for future cost increases or
decreases.

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CASE 6-47 (CONTINUED)

5.

a.

Variable OH1 (50 5 $4.15)....................................................................... $1,037.50

Variable OH2 (50 $13.60)............................................................................ 680.00
Variable OH3 (70 $5.90).............................................................................. 413.00
Total incremental variable overhead........................................................... $2,130.50

b.

Variable OH1 (50 5 $4.15)....................................................................... $1,037.50

Variable OH2 (25 $13.60)............................................................................ 340.00
Variable OH3 (230 $5.90)............................................................................ 1,357.00
Total incremental variable overhead........................................................... $2,734.50

c.

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

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CASE 6-48 (45 MINUTES)

1.

Scatter diagram:

Administrative cost
$25,000

$20,000

$15,000

$10,000

$5,000

2.
Visually-fitted
curvilinear
cost line

4.
Visually-fitted
semivariable
cost line

500

1,000

1,500

2,000

Patient load

3. Relevant range

2. through 4.
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See scatter diagram for requirement (1).

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CASE 6-48 (CONTINUED)

5.

Fixed cost = $7,000

Variable cost per patient

$10,600 $7,000
$3.00
1,200 0

6.

Administrative cost = $7,000 + $3.00X, where X denotes the number of patients.

7.

Cost predictions using visually-fit cost lines:

Patient
Load

Cost
Prediction

750.....................
$9,300
350.
5,500
It makes no difference which visually-fit cost line is used to make the cost prediction
for 750 patients. The semivariable approximation is very accurate at this patient load,
which is near the middle of the relevant range. However, for a patient load of 350
patients, the visually-fit curvilinear cost line yields a much more accurate prediction.
CASE 6-49 (50 MINUTES)
1.

High-low method:
Variable administrative cost per patient =

$16,100 $4,100
$10
1,500 300

Total cost at 1,500 patients...........................................................................

Variable cost at 1,500 patients......................................................................
Fixed cost per month....................................................................................

$16,100
15,000
$1,100

Cost formula:
Total monthly administrative cost = $1,100 + $10X, where X denotes the number of
patients for the month.
The variable cost per patient is $10.

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2.

The electronic version of the Solutions Manual BUILD A SPREADSHEET

SOLUTIONS is available on your Instructors CD and on the Hilton, 8e website:
www.mhhe.com/hilton8e.

CASE 6-49 (CONTINUED)

3.

Memorandum
Date:

Today

To:

Jeffrey Mahoney, Administrator

From:

I.M. Student

Subject: Comparison of cost estimates for clinic administrative costs

Three alternative cost-estimation methods were used to estimate the pediatric clinic's
administrative cost behavior. The results of these three approaches (in formula form)
are shown below. In each formula, X denotes the number of patients in a month.
(a)

Least-squares regression method:

Total monthly administrative cost = $2,671 + $7.81X

(b) High-low method:

Total monthly administrative cost = $1,100 + $10X
(c)

Visual-fit method:
Total monthly administrative cost = $7,000 + $3.00X

These cost estimates differ very significantly. The activity level in the clinic
during its first year of operation fluctuated greatly. This fluctuation is not expected in
the future; patient loads in the range of 600 to 1,200 patients per month are
anticipated.

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The cost estimates differ so greatly because two of the methods (least-squares
and high-low) used data from outside the relevant range of activity. The clinic's
administrative cost behavior appears from the scatter diagram to be curvilinear over
the entire range. The 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. Since 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. In
this instance, the visually-fitted cost line probably provides the best estimate.

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CASE 6-49 (CONTINUED)

Another possible approach would be to use least-squares regression, but
restrict the data to those observations within the relevant range. However, only a
handful of observations would remain to include in the analysis.
My overall recommendation is to use the visually-fitted cost line as the best
estimate until the clinic has operated for its second year. Then I would recommend a
new cost analysis using least-squares regression on all of the data from the relevant
range of activity.
4.

It is very inappropriate for the hospital administrator to manipulate the cost

information supplied by the director of cost management in order to push his own
agenda before the board of trustees. It is the board's legitimate role to decide whether
or not to establish and continue operations in the clinic. In making decisions about
the clinic, the board should have the best information possible, including the
controller's best estimate as to how administrative costs will behave.
Megan McDonough, the hospitals director of cost management, has a
professional obligation to provide her best professional judgment to the board of
trustees. The standards of ethical conduct for management accountants include the
following requirements concerning objectivity:
(a)

Communicate information fairly and objectively.

(b) Disclose fully all relevant information that could reasonably be expected to
influence an intended user's understanding of the reports, comments, and
recommendations presented.
McDonough should insist that the best and most appropriate estimate of the
clinic's administrative cost behavior be presented to the board.

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CASE 6-49 (CONTINUED)

The following alternative approach to calculating the regression parameters is not a
requirement in the problem.
Least-squares regression using manual calculations
(a)

Tabulation of data:
Dependent
Variable
(cost in
hundreds)
Y
60
70
139
92
119
100
94
41
102
161
83
111
1,172

Month
January.......................
February......................
March..........................
April.............................
May..............................
June............................
July..............................
August........................
September..................
October.......................
November...................
December....................
Total............................

Independent
Variable
(patients in
hundreds)
X
4
5
14
9
13
10
7
3
11
15
6
12
109

X2
16
25
196
81
169
100
49
9
121
225
36
144
1,171

XY
240
350
1,946
828
1,547
1,000
658
123
1,122
2,415
498
1,332
12,059

(b) Calculation of parameters:

( Y )( X 2 ) ( X )( XY )
a =
n( X 2 ) ( X )( X )
=
b =
=

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(1,172)(1,171) (109)(12,059)
26.707 (rounded)
(12)(1,171) (109)(109)

n( XY) ( X)( Y)
n( X 2 ) ( X)( X)
(12)(12,059) (109)(1,172)
7.812 (rounded)
(12)(1,171) (109)(109)

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CASE 6-49 (CONTINUED)

(c)

Cost behavior in formula form (with rounded parameters):*

Total monthly administrative cost = $2,671 + $7.81X, where X denotes the
number of patients for the month.
*When interpreting the regression parameters, remember that both the cost and
patient data were transformed to hundreds. Thus, the 26.707 intercept parameter
(a) is in terms of hundreds of dollars of cost, or $2,671 (rounded). The 7.812
slope parameter (b) is in terms of hundreds of dollars of cost per hundred
patients, or $781 (rounded) per hundred patients. This amount is equivalent to
$7.81 per patient.

(d)

The variable cost per patient is $7.81, as explained above.

FOCUS ON ETHICS (See page 253 in the text.)

Is direct labor a variable cost? Is it ethical to tap and zap employees?
Direct labor is a variable cost if management is both able and willing to continually
adjust the workforce to meet short-term needs. Many observers would argue that it is
ethical to tap and zap employees provided that those employees are appropriately
notified about and compensated for the added risks and uncertainties surrounding their
employment. For example, hourly rates for temporary employees may be set somewhat
higher than for permanent employees to account for temps not having paid vacation,
health benefits, and other standard compensation features of the modern workforce.
For many cyclical industries (e.g., recreational resorts) such labor flexibility is essential.
For industries with more stable labor levels, there are legal limitations, which seek to
prevent classifying labor incorrectly as temporary. The deliberate misclassification of
employees to avoid appropriate compensation is unethical, and in certain
circumstances may be illegal.

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