CHAPTER 7

Activity Analysis, Cost Behavior, and Cost Estimation

MULTIPLE CHOICE

Ans 1. The relationship between cost and activity is termed:

LO 1 A. cost estimation.
RC B. cost prediction.
C. cost behavior.
D. cost analysis.
E. cost approximation.

Ans 2. Which of the following costs changes in direct proportion to a change in the activity
LO 2 level?
RC A. Variable cost.
B. Fixed cost.
C. Semivariable cost.
D. Step-variable cost.
E. Step-fixed cost.

Ans 3. Norman Company pays a sales commission of 5% on each unit sold. If a graph is
LO 2 prepared, with the vertical axis representing per-unit cost and the horizontal axis
N representing units sold, how would a line representing sales commissions be drawn?
A. As a straight diagonal line, sloping upward to the right.
B. As a straight diagonal line, sloping downward to the right.
C. As a horizontal line.
D. As a vertical line.
E. As a curvilinear line.
Ans 4. Webster has the following budgeted costs at its anticipated production level
LO 2 (expressed in hours): variable overhead, $150,000; fixed overhead, $240,000. If
N Webster now revises its anticipated production slightly downward, it would expect:
A. total fixed overhead of $240,000 and a lower hourly rate for variable
overhead.
B. total fixed overhead of $240,000 and the same hourly rate for variable
overhead.
C. total fixed overhead of $240,000 and a higher hourly rate for variable
overhead.
D. total variable overhead of less than $150,000 and a lower hourly rate for
variable overhead.
E. total variable overhead of less than $150,000 and a higher hourly rate for
variable overhead.

Ans 5. Costs that remain the same over a wide range of activity, but jump to a different
LO 2 amount outside that range, are termed:
RC A. step-fixed costs.
B. step-variable costs.
C. semivariable costs.
D. curvilinear costs.
E. mixed costs.

Ans 6. A cost that has both a fixed and variable component is termed a:
LO 2 A. step-fixed cost.
RC B. step-variable cost.
C. semivariable cost.
D. curvilinear cost.
E. discretionary cost.

Ans 7. Richard Hamilton has a fast-food franchise and must pay a franchise fee of $35,000
LO 2 plus 3% of gross sales. In terms of cost behavior, the fee is a:
N A. variable cost.
B. fixed cost.
C. step-fixed cost.
D. semivariable cost.
E. curvilinear cost.
Ans 8. Which of the following are examples of a mixed cost?
LO 2 I ─ A building that is used for both manufacturing and sales activities.
N II ─ An employee’s compensation, which consists of a flat salary plus a
commission.
III ─ Depreciation that relates to five different machines.
IV ─ Maintenance cost that must be split between sales and administrative offices.
A. I.
B. II.
C. I and III.
D. I, III, and IV.
E. I, II, III, and IV.

Ans 9. Which of the following costs exhibits both decreasing and increasing marginal costs
LO 2 over a specific range of activity?
RC A. Semivariable cost.
B. Curvilinear cost.
C. Step-fixed cost.
D. Step-variable cost.
E. Fixed cost.

Ans 10. The relevant range is that range of activity:

LO 3 A. where a company achieves its maximum efficiency.
RC B. where units produced equal units sold.
C. where management expects the firm to operate.
D. where the firm will earn a profit.
E. where expected results are abnormally high.

Ans 11. Within the relevant range of activity, costs:

LO 3 A. can be estimated with reasonable accuracy.
RC B. can be expected to change radically.
C. exhibit decreasing marginal cost patterns.
D. exhibit increasing marginal cost patterns.
E. cannot be estimated satisfactorily.

Ans 12. Within the relevant range, a curvilinear cost function can often be graphed as a:
LO 3
RC A. straight line.
B. jagged line.
C. vertical line.
D. curved line.
E. horizontal line.
Ans 13. As a firm begins to operate outside the relevant range, the accuracy of cost estimates
LO 3 for fixed and variable costs:
N Fixed Variable
A. increases increases
B. increases decreases
C. decreases increases
D. decreases decreases
E. decreases remains unchanged

Ans 14. A variable cost that has a definitive physical relationship to the activity measure is
LO 4 called a(n):
RC A. discretionary cost.
B. engineered cost.
C. managed cost.
D. programmed cost.
E. committed cost.

Ans 15. Costs that result from an organization’s ownership or use of facilities and its basic
LO 4 organizational structure are termed:
RC A. discretionary fixed costs.
B. committed fixed costs.
C. discretionary variable costs.
D. committed variable costs.
E. engineered costs.

Ans 16. Which of the following is not an example of a committed fixed cost?
LO 4 A. Property taxes.
RC B. Depreciation on buildings.
C. Salaries of management personnel.
D. Contributions to charitable organizations.
E. Equipment rental costs.

Ans 17. Which of the following would not typically be classified as a discretionary fixed cost?
LO 4
RC A. Property taxes.
B. Employee development (education) programs.
C. Advertising.
D. Outlays for research and development.
E. Charitable contributions.
Ans 18. Which type of fixed cost (1) tends to be more long-term in nature and (2) can be cut
LO 4 back more easily in bad economic times without doing serious harm to organizational
N goals and objectives?
Long-term in Can be Cut Back More Easily in
Nature Bad Economic Times
A. Committed Committed
B. Committed Discretionary
C. Discretionary Committed
D. Discretionary Discretionary
E. Committed No difference between
committed and discretionary

Ans 19. High-tech automation combined with labor union negotiations that have produced a
LO 4 relatively stable workforce have resulted in:
RC A. increased fixed costs and increased variable costs.
B. increased fixed costs and reduced variable costs.
C. reduced fixed costs and increased variable costs.
D. reduced fixed costs and reduced variable costs.
E. increased discretionary fixed costs and reduced committed fixed costs.

Ans 20. Which of the following techniques is not used to analyze cost behavior?
LO 5 A. Least-squares regression.
RC B. High-low method.
C. Visual-fit method.
D. Linear programming.
E. Multiple regression.

Ans 21. The nonstatistical method of cost estimation that calls for the creation of a scatter
LO 5 diagram is the:
RC A. least-squares regression method.
B. high-low method.
C. visual-fit method.
D. account analysis method.
E. multiple regression method.

Ans 22.. Which of the following statements about the visual-fit method is (are) true?
LO 5 I ─ The visual-fit method results in the creation of a scatter diagram.
RC II ─ The visual-fit method is not totally objective because of the manner in which
the cost line is determined.
III ─ The visual-fit method is especially helpful in the determination of outliers.
A. I.
B. II.
C. I and II.
D. I and III.
E. I, II, and III.

Ans 23. Which of the following methods of cost estimation relies on only two data points?
LO 5
RC A. Least-squares regression.
B. The high-low method.
 C. The visual-fit method.
D. Account analysis.
E. Multiple regression.

Use the following information to solve multiple-choice questions 24 - 25.

Lawson and Associates presently leases a copy machine under an agreement that calls for a
fixed fee each month and a charge for each copy made. Lawson made 2,400 copies and paid a
total of $182 in September; in October, the firm paid $215 for 3,500 copies. The company
uses the high-low method to analyze costs.

Ans 24. Lawson’s variable cost per copy is:

LO 5 A. $0.03.
A B. $0.04.
C. $0.05.
D. $0.06.
E. an amount other than those given above.

Ans 25. Lawson’s monthly fixed fee is:

LO 5 A. $38.
A B. $75.
C. $86.
D. $110.
E. an amount other than those given above.
 Use the following information to solve multiple-choice questions 26 - 28.

Yang Manufacturing, which uses the high-low method, makes a product called Yin. The
company incurs three different cost types (A, B, and C) and has a relevant range of operation
between 2,500 units and 10,000 units per month. Per-unit costs at two different activity levels
for each cost type are presented below.

Type A Type B Type C Total

5,000 units $4 $9 $4 $17
7,500 units $4 $6 $3 $13

Ans 26. Each of the cost types shown above is identified by behavior as:
LO 2, 5 Type A Type B Type C
A, N A. Fixed Variable Semivariable
B. Fixed Semivariable Variable
C. Variable Semivariable Fixed
D. Variable Fixed Semivariable
E. Semivariable Variable Fixed

Ans 27. If Yang produces 10,000 units, the total cost would be:
LO 5 A. $90,000.
A B. $100,000.
C. $110,000.
D. $125,000.
E. $130,000.

Ans 28. The cost formula that expresses the behavior of Yang ’s total costs is:
LO 5 A. Y = $0 + $17X.
A B. Y = $20,000 + $13X.
C. Y = $40,000 + $9X.
D. Y = $45,000 + $4X.
E. Y = $60,000 + $5X.
 Use the following information to solve multiple-choice questions 29 - 31.

Atlanta, Inc., which uses the high-low method to analyze cost behavior, has determined that
machine hours best explain the company’s utilities cost. The company ’s relevant range of
activity varies from a low of 600 machine hours to a high of 1,100 machine hours, with the
following data being available for the first six months of the year:

Month Utilities Machine Hours

January $8,700 800
February 8,360 720
March 8,950 810
April 9,360 920
May 9,625 950
June 9,150 900

Ans 29. The variable utilities cost per machine hour is:
LO 5 A. $0.18.
A B. $4.50.
C. $5.00.
D. $5.50.
E. an amount other than those listed above.

Ans 30. The fixed utilities cost per month is:

LO 5 A. $3,764.
A B. $4,400.
C. $4,760.
D. $5,100.
E. an amount other than those listed above.

Ans 31. Using the high-low method, the utilities cost associated with 980 machine hours
LO 5 would be:
A A. $9,510.
B. $9,660.
C. $9,700.
D. $9,790.
E. an amount other than those listed above.

Ans 32. Of the following methods, which is generally thought to be the most accurate with
LO 5 respect to determining cost behavior?
RC A. Least-squares regression.
B. The high-low method.
C. The visual-fit method.
D. Account analysis.
E. The scatter diagram method.

Ans 33. In regression analysis, the variable that is being predicted is known as the:
LO 5 A. independent variable.
RC B. dependent variable.
C. explanatory variable.
 D. interdependent variable.
E. functional variable.

Ans 34. Simon Corporation, which uses least-squares regression analysis, has derived the
LO 5 following regression equation for estimates of manufacturing overhead:
N Y = 565,000 + 7.85X. Which of the following statements is true if the primary cost
driver is machine hours?
A. Total manufacturing overhead is represented by the variable “X. ”
B. The company anticipates $565,000 of fixed manufacturing overhead.
C. “X” is commonly known as the dependent variable.
D. “X” represents the number of machine hours.
E. Both “b” and “d” are true.

Ans 35. Waller Enterprises has determined that three variables play a key role in determining
LO 6 company revenues. To arrive at an objective forecast of revenues for the next
N accounting period, Waller should use:
A. simple regression.
B. multiple regression.
C. a scatter diagram.
D. complex regression.
E. the high-low method.

Ans 36. Which of the following is not an issue in the collection of data for cost estimation?
LO 6
RC A. Outliers.
B. Missing data.
C. Mismatched time periods.
D. The effects, over time, of inflation and the learning (i.e., efficiency
improvement) that takes place in repetitive tasks.
E. All of the above are issues in data collection.

Ans 37. All cost estimation methods (except multiple regression) assume that:
LO 6 I ─ the movement of a given cost can basically be explained by a single cost
RC driver (i.e., activity variable).
II ─ cost behavior is linear within the relevant range.
III ─ all costs behave in the same manner for all firms.
Which of the above statements is (are) true?
A. I.
B. I and II.
C. I and III.
D. II and III.
E. I, II, and III.

Ans 38. The systematic analysis of a task to determine the inputs needed to perform that task
LO 6 (e.g., processing steps, time, number of employees, materials, and so forth) is termed:
RC
A. work measurement.
B. labor analysis.
C. factor determination.
D. capital budgeting.
 E. task analysis.

Ans 39. A control factor unit:

LO 6 I ─ cannot be used in a manufacturing environment.
RC II ─ is associated with a technique called work measurement.
III ─ may be defined as claims processed if an insurance company is studying its
claims-processing activities.
Which of the above statements is (are) true?
A. I.
B. I and II.
C. I and III.
D. II and III.
E. I, II, and III.

Ans 40. A high R2 measure in regression analysis is preferred because:

LO 7 A. it indicates a good fit of the regression line through the data points.
RC B. it shows that a great deal of the change in the dependent variable is explained
by change in the independent variable.
C. it means that the independent variable is a good predictor of the dependent
variable.
D. it means that the cost analyst can be relatively confident in his or her cost
predictions.
E. all of the preceding statements are true.
 EXERCISES

Cost Behavior Patterns in a Variety of Settings

LO 2 41. Consider the graphs that follow (the horizontal axis represents activity; the vertical
N axis represents total dollars).

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

A. Property taxes on a factory.

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. The total salary cost of shift supervisors at a truck depot. Each shift is 8
hours, and the depot operates with one, two, or three shifts at various times
of the year.
E. The cost of sheet metal used to manufacture automobiles.

F. Freight-out 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 very 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. The cost of telephone service, which is based on the number of message

units per month. The charge is $2 per message unit, for up to 1,000
message units. Additional message units above 1,000 are free.

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

Cost Classification, Cost Equation

LO 2, 5 42. Clarion Valley Meat Company produces one of the best sausage products in
N, A Pennsylvania. The company's controller compiled the following information by
analyzing the accounting records:
1. Meat costs the company $2.00 per pound of sausage produced.
2. Monthly depreciation on buildings and equipment is $40,000.
3. Compensation of production employees is $1.60 per pound of sausage
produced.
4. Supervisory salaries total $16,000 per month.
5. The company incurs utility costs of $8,000 per month plus $0.40 per pound
of sausage produced.

REQUIRED:
A. Classify each cost as variable, fixed, or semivariable.
B. Write a cost formula to express the cost behavior of the firm's production
costs. (Use the form Y = a + bX, where X denotes the quantity of sausage
produced.)
High-low Method vs. Visual-fit Method
LO 5 43. Monroe Company would like to determine the variable rate per direct machine hour in
A, N order to estimate the utilities cost for May. Relevant information is as follows.

Machine
Hours Utilities
Month Worked Cost
January 2,400 $2,060
February 2,600 2,122
March 2,800 2,241
April 3,000 2,420

Monroe anticipates producing 1,850 units in May, 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 cost components of the utilities cost.
B. Using the data calculated above, estimate the utilities cost for May.
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.

Cost Estimation, High-low Method, Relevant Range

LO 2, 44. The Arlington Medical Clinic offers a number of specialized medical services. A
3, 5 review of data for the year just ended revealed variable costs of $25 per patient day,
A, N annual fixed costs of $300,000, and semivariable costs, which displayed the following
behavior at the “peak” and “valley” of activity:

March (2,200 patient days)--$246,000

August (2,700 patient days)--$261,000

REQUIRED:
A. Calculate the total cost for an upcoming month (2,600 patient days) if
current cost behavior patterns continue. Arlington uses the high-low method
to analyze cost behavior.
B. There is a high probability that Arlington’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
2,600 patient days be employed to estimate the costs for, say, 4,000 patient
days? Why or why not?

Cost Estimation, High-low Method, Analysis of Step-fixed Cost

LO 2, 45. A-1 Corporation extracts ore for eight different companies in Colorado. The firm
5 anticipates variable costs of $65 per ton along with annual overhead of $840,000,
A, N 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 are
expected to be extracted.
B. Calculate the total cost for that same month.
C. A-1 uses Cortez Trucking to haul extracted ore. Cortez ’s monthly schedule
of charges is 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.
Using and Analyzing a Regression Equation
LO 5 46. Brown Company manufactures several different products. The company is making
A, N plans for the introduction of a new product, with a target price of $4 per unit. The
following estimates of manufacturing costs have been derived for 5 million units, to
be produced during the first year:

Direct material $2,500,000

Direct labor 1,000,000 (at $8 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:
Fixed overhead cost $2,000,000
Coefficient of independent variable $11

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 80,000 units.
C. What is Brown’s dependent variable in this case?
D. How can the company evaluate the “quality” of its regression equation?
High-low and Regression Analysis, Interpretation
LO 5 47. Managers in the Stamping Department have been studying overhead cost and its
A, N relationship with machine hours. Data from the most recent 12 months follows.

Machine
Month Overhead 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
R² 0.79 R² 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.

DISCUSSION QUESTIONS
Cost Behavior Characteristics
LO 2 48. Compare and contrast the following types of costs: (1) variable and step-variable and
RC (2) fixed and step-fixed.

The Relevant Range

LO 3 49. Define the term ”relevant range” and explain its importance in understanding cost
RC behavior.

Committed Costs and Discretionary Costs

LO 4 50. Differentiate between committed costs and discretionary costs. Be sure to present two
RC examples of each and explain which of the two cost types would likely be cut should a
company encounter financial difficulties.

Least-squares Regression and Multiple Regression

LO 5, 6 51. Distinguish between least-squares regression and multiple regression as cost
RC estimation methods.