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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Managerial Accounting, 8/e 6- 1
 6.4 Graphs of the cost behavior patterns are as follows:

Cost Cost

Activity Activity
a. Variable b. Step-variable

Cost Cost

Activity Activity
c. Fixed d. Step-fixed
Cost Cost

Activity Activity
e. Semivariable
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6-2 Solutions Manual
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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Managerial Accounting, 8/e 6- 3
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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6-4 Solutions Manual
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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Managerial Accounting, 8/e 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 R 2.

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6-6 Solutions Manual
SOLUTIONS TO EXERCISES
EXERCISE 6-22 (15 MINUTES)

1.
Cost per Broadcast Hour
Cost Item August October
Production crew:
$5,330/410 hr..................................... $13.00 per hr.
$8,840/680 hr..................................... $13.00 per hr.
Supervisory employees:
$6,000/410 hr..................................... $14.63 per hr.*
$6,000/680 hr..................................... $ 8.82 per hr.*

*Rounded.

2. December cost predictions:

Production crew (440  $13.00 per hr.).................................... $5,720

Supervisory employees........................................................... 6,000

3.
Cost per Broadcast Hour
Cost Item in December
Production crew................................................ $13.00 per hr.    
Supervisory employees ($6,000/440 hr.)............ 13.64 per hr.*

*Rounded.

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Managerial Accounting, 8/e 6- 7
EXERCISE 6-23 (40 MINUTES)

1. Cost of food:

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6-8 Solutions Manual
EXERCISE 6-23 (CONTINUED)

2. Cost of salaries and fringe benefits for administrative staff:

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Managerial Accounting, 8/e 6- 9
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

Patient days
1,000 2,000 3,000

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6-10 Solutions Manual
EXERCISE 6-23 (CONTINUED)

4. Cost of utilities:

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Managerial Accounting, 8/e 6- 11
EXERCISE 6-23 (CONTINUED)

5. Nursing costs:

Cost per month

$17,50
0
$15,00
0
$12,50 Total cost
0
$10,00
0
$7,500

$5,000

$2,500

Patient days
200 400 600 800 1,000

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6-12 Solutions Manual
EXERCISE 6-24 (15 MINUTES)

1. a. Fixed

b. Variable

c. Variable

d. Fixed

e. Semivariable (or mixed)

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

*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 = (18,750 r -16,500 r ) / (30,000 miles – 12,000 miles)
= .125 r

r denotes the real , Brazil’s national currency.

Total maintenance cost at 12,000 miles........................................... 16,500 r

Variable maintenance cost at 12,000 miles (.125 r  12,000)............. 1,500 r
Fixed maintenance cost per month.................................................. 15,000 r

2. Cost formula:

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

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

Maintenance cost = 15,000 r + (.125 r )(34,000)

= 19,250 r

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Managerial Accounting, 8/e 6- 13
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.
Actual Estimated
a. 20,000 miles....................................................... $1,950 $2,200
b. 40,000 miles....................................................... 2,600 2,600
c. 60,000 miles....................................................... 3,000 3,000
d. 90,000 miles....................................................... 4,250 3,600

2. (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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6-14 Solutions Manual
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

Tests
500 1,000 1,500 2,000 2,500 3,000 3,500

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Managerial Accounting, 8/e 6- 15
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............................................................................... $14,000

Variable cost per diagnostic test.......................................................... $ 10.56*

*Calculation of variable cost:

Total cost at 3,600 tests..................................... $52,000

Total cost at     0 tests.....................................   14,000
Difference: 3,600 tests..................................... $38,000

$38,000
Variable cost per diagnostic test = 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 manager’s salary: fixed

Property taxes: fixed

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6-16 Solutions Manual
EXERCISE 6-29 (15 MINUTES)

Variable cost per pint of applesauce produced =

1. $72,300 $66,300
 $.10
123,000 63,000

Total cost at 123,000 pints............................................................. $72,300

Variable cost at 123,000 pints
(123,000  $.10 per pint).......................................................  12,300
Fixed cost..................................................................................... $60,000

Cost equation:

Total energy cost = $60,000 + $.10 X, 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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Managerial Accounting, 8/e 6- 17
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

Pints of apple-
30,000 60,000 90,000 120,000 150,000 sauce produced

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6-18 Solutions Manual
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) Average time for 4 satellites.................................................... 195 hours

(b) Average time for 8 satellites.................................................... 150 hours

2. (a) Total time for 4 satellites (195 hr. X 4).................................... 780 hours
(b) Total time for 8 satellites (150 hr. X 8).................................... 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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Managerial Accounting, 8/e 6- 19
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

Tax
returns
20 40 60 80 100 audited

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6-20 Solutions Manual
EXERCISE 6-33 (45 MINUTES)

$3,800 $2,600
1. Variable utility cost per = = $4.00
700  400
hour

Total utility cost at 700 hours........................................................... $ 3,800

Variable utility cost at 700 hours ($4.00  700 hours).......................   2,800
Fixed cost per month...................................................................... $ 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 600 hours ............................................................. $3,400

Cost at   0 hours .............................................................    900
Difference 600 hours ............................................................. $2,500

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

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Managerial Accounting, 8/e 6- 21
 EXERCISE 6-33 (CONTINUED)

Scatter diagram and visually-fit line:

Utility cost
per month

Hours of
operation

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6-22 Solutions Manual
EXERCISE 6-33 (CONTINUED)

3. Estimation of variable- and fixed-cost 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.

4. Cost predictions at 300 hours of operation:

(a) High-low method:

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

(b) 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 R 2:

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SOLUTIONS” is available on your Instructors CD and on the Hilton, 8e website:
WWW.MHHE.COM/HILTON8E.

The R 2 is .9518.

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Managerial Accounting, 8/e 6- 23
 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 Independent
Variable Variable
(cost) (hours)
Month Y X X2 XY
January................... 3,240 550 302,500 1,782,000
February.................. 3,400 600 360,000 2,040,000
March...................... 3,800 700 490,000 2,660,000
April......................... 3,200 500 250,000 1,600,000
May......................... 2,700 450 202,500 1,215,000
June........................ 2,600   400   160,000 1,040,00
0
Total........................ 18,940 3,200 1,765,000 10,337,00
0

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

(c) Cost formula:

Monthly utility cost = $1,002 + $4.04 X , where X denotes hours of

operation.

Variable utility cost = $4.04 per hour of operation

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6-24 Solutions Manual
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:

Independent
Dependent Variable
Variable (thousands
(cost in of
thousands) passengers)
Month Y X X2 XY
July......................... 54 16 256 864
August..................... 54 17 289 918
September............... 57 16 256 912
October................... 60 18 324 1,080
November................ 54 15 225 810
December................ 57 17   289 969
Total........................ 336 99 1,639 5,553

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Managerial Accounting, 8/e 6- 25
EXERCISE 6-34 (CONTINUED)

(b) Calculation of parameters:

( Y )( X 2 )  (  X )( XY )
a =
n (  X 2 )  (  X )( X )
9)  (99)(5,553
(336)(1,63 )
=  29 (rounded)
(6)(1,639) (99)(99)

n(  XY)  (  X)(  Y)
b =
n(  X 2 )  (  X)(  X)
(6)(5,553) (99)(336)
=  1.636(rounded)
(6)(1,639) (99)(99)

(c) Cost formula:

Monthly cost of flight service = $29,000 + $1,636X, where X denotes

thousands of passengers.

Calculation and interpretation of R 2 using manual calculations:

(a) Formula for calculation:

(Y  Y ') 2
R 2  1
(Y Y ) 2

where Y 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.

Y denotes the mean (average) observation of the dependent

variable (cost).

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6-26 Solutions Manual
EXERCISE 6-34 (CONTINUED)

(b) Tabulation of data:*

Predicted Cost
(in thousands)
Based on
Regression
Month Y X Line Y' [( Y – Y' ) 2] † [( Y – Y ) 2] †
July.............. 54 16 55.176 1.383 4.000
August.......... 54 17 56.812 7.907 4.000
September.... 57 16 55.176 3.327 1.000
October........ 60 18 58.448 2.409 16.000
November..... 54 15 53.540 .212 4.000
December..... 57 17 56.812 .035 1.000
Total............. 15.273 30.000

* Y' = ($29,000 + $1,636 X )/$1,000

Y =
 Y/6 = 56
†
Rounded.

(c) Calculation of R 2:

15.273
R2 = 1 – = .49 (rounded)
30.000

(d) Interpretation of R 2:

The coefficient of determination, R 2, is a measure of the goodness of fit of the

least-squares regression line. An R 2 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 R 2, the better the
regression line fits the data. The interpretation of a high R 2 is that the
independent variable is a good predictor of the behavior of the dependent
variable. In cost estimation, a high R 2 means that the cost analyst can be
relatively confident in the cost predictions based on the estimated-cost
behavior pattern.

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Managerial Accounting, 8/e 6- 27
SOLUTIONS TO PROBLEMS
PROBLEM 6-35 (20 MINUTES)

1. h 5. a 9. d

2. i 6. g 10 k
.

3. f 7. c 11. l

4. e 8. b

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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6-28 Solutions Manual
PROBLEM 6-37 (25 MINUTES)
$4,710  $2,990
1. Variable maintenance cost per hour of =
525  310
service

= $8.00

Total maintenance cost at 310 hours of service................................ $2,990

Variable maintenance cost at 310 hours of service (310 hr.  $8.00).  2,480
Fixed maintenance cost per month.................................................. $  510

Cost formula:

Monthly maintenance cost = $510 + $8.00 X , 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)]................................... $8.00

Fixed cost per hour at 610 hours of activity ($510/610) .................... $ .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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Managerial Accounting, 8/e 6- 29
PROBLEM 6-38 (25 MINUTES)

1. Straight-line depreciation—committed fixed

Charitable contributions—discretionary fixed
Mining labor/fringe benefits—variable
Royalties—semivariable
Trucking and hauling—step-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:

June December
(2,700 (1,400
tons) tons)

Total royalty $224,500 $140,000

cost……………………….
Less: Variable cost at $65 per 175,500 91,000
ton…..
Fixed royalty $ 49,000 $ 49,000
cost………………………

2. Total cost for 1,700 tons:

Depreciation………………………………………… $ 30,000
...
Charitable ----
contributions…………………………….
Mining labor/fringe benefits at $225 per 382,500
ton…….
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6-30 Solutions Manual
 Royalties:
Variable at $65 per 110,500
ton…………………………..
Fixed…………………………………………… 49,000
…..
Trucking and 280,000
hauling………………………………..
Total……………………………………………… $852,000
..

McGraw-Hill/Irwin  2009 The McGraw-Hill Companies,

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Managerial Accounting, 8/e 6- 31
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 entity’s 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 company’s 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 it’s 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

year-end, it may have ample funds available and decide to make donations to
charitable causes. Such contributions are deductible in computing the company’s
tax obligation to the government. Tax deductions reduce taxable income and,
therefore, produce a tax savings for the firm.

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6-32 Solutions Manual
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:

April June

(23,000 (34,000
hours) hours)

Total $ 681,000 $ 879,000

cost*……………………..
Less: Machine (103,50 (153,00
supplies……. 0) 0)
Depreciation…………. (22,50 (22,50
. 0) 0)
Plant $ 555,000 $ 703,500
maintenance…………...

* 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:

April June
(23,000 (34,000
hours) hours)

Total maintenance cost........................ $555,000 $703,500

Less: Variable cost at $13.50 per hour. 310,500 459,000
Fixed maintenance cost....................... $244,500 $244,500

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Managerial Accounting, 8/e 6- 33
PROBLEM 6-39 (CONTINUED)

3. Manufacturing overhead at 29,500 labor hours:

Machine supplies at $4.50 per hour........... $132,750

Depreciation............................................. 22,500
Plant maintenance cost:
Variable at $13.50 per hour.................. 398,250
Fixed.................................................. 244,500
Supervisory labor..................................... 135,000
Total............................................ $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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6-34 Solutions Manual
PROBLEM 6-40 (40 MINUTES)

1.

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Managerial Accounting, 8/e 6- 35
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 Cost
0................................................................................. $
9,700
2,000.......................................................................... 11,700

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

$11,700 $9,700
Variable cost per unit of activity* = 2,000 0

= $1.00

*Pounds (in hundreds) of equipment loaded or unloaded

4. Cost equation:

Total material-handling cost = $9,700 + $1.00 X , where X denotes the number

pounds (in hundreds) of equipment loaded or unloaded during the month.

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6-36 Solutions Manual
PROBLEM 6 -40 (Continued)

5. High-low method:

Variable cost unit of activity* = $12,120 $10,200

2,600 1,000
= $1.20

*Pounds (in hundreds) of equipment loaded or unloaded

Total cost at 2,600 units of activity.................................................... $12,120

Deduct: Variable cost at 2,600 units of activity (2,600  $1.20)..........   3,120
Fixed cost........................................................................................ $ 9,000

Cost equation based on high-low method:

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

McGraw-Hill/Irwin  2009 The McGraw-Hill Companies,

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Managerial Accounting, 8/e 6- 37
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 Using

Cost Line* High-Low Method
$11,950 = $9,700 + ($1.00)(2,250) $11,700 = $9,000 + ($1.20)
(2,250)

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

data in developing the cost equation.

McGraw-Hill/Irwin  2009 The McGraw-Hill Companies,

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6-38 Solutions Manual
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 cost-
estimation 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 R 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.

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Managerial Accounting, 8/e 6- 39
 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:

Independent
Dependent Variable
Variable (units of
(cost in activity in
thousands) thousands)
Month Y X X2 XY
January...................  11.70   1.8  3.24  21.060
February.................. 11.30 1.6 2.56 18.080
March...................... 11.25 1.3 1.69 14.625
April......................... 10.20 1.0 1.00 10.200
May......................... 11.10 2.2 4.84 24.420
June........................ 12.55 2.4 5.76 30.120
July......................... 12.00 2.0 4.00 24.000
August..................... 11.40 1.8 3.24 20.520
September............... 12.12 2.6 6.76 31.512
October................... 11.05 1.1 1.21 12.155
November................ 11.35 1.2 1.44 13.620
December................ 11.35 1.4 1.96 15.890
Total........................ 137.37 20.4 37.70 236.202

(b) Calculation of parameters:

( Y )( X 2 )  (  X )( XY )
a =
n (  X 2 )  (  X )( X )
7.7)  (20.4)(236
(137.37)(3 .202)
=  9.943(rounded)
(12)(37.7) (20.4)(20.
4)

n(  XY)  (  X)(  Y)
b =
n(  X 2 )  (  X)(  X)
(12)(236.202)  (20.4)(137.37)
=  .885 (rounded)
(12)(37.7) (20.4)(20.4)

McGraw-Hill/Irwin  2009 The McGraw-Hill Companies,

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6-40 Solutions Manual
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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Managerial Accounting, 8/e 6- 41
PROBLEM 6-42 (40 MINUTES)

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6-42 Solutions Manual
PROBLEM 6-42 (CONTINUED)

3. Fixed-cost component = $13,005

Variable-cost component:

Variable cost $13,205 $13,005

=
per golfer 200  0
= $1
Cost equation:

Maintenance cost per month = $13,005 + $1 X , where X denotes the number of

golfers during the month.

4. Predicted Course Maintenance Costs

Using Fixed
Cost Coupled
with Step-
Variable Cost Using
Behavior Semivariable
Pattern Cost
Approximation
150 people tee off.......................... $13,150 $13,155
158 people tee off.......................... 13,160 13,163

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Managerial Accounting, 8/e 6- 43
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. April August
Beginning inventory.................................................... $1,300 $1,000
+ Purchases............................................................... 5,900 6,200
– Ending inventory.....................................................  (1,350)  (3,000)
Indirect material used................................................. $5,850 $4,200

5. High-low method:

Variable cost per machine hour

difference in cost levels

= difference in activity levels
$5,850 $4,200 $1,650
=   $5.50per machine hour
1,000 700 300

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6-44 Solutions Manual
PROBLEM 6-43 (CONTINUED)

Fixed cost per month:

Total cost at 1,000 hours.................................................................. $5,850

Variable cost at 1,000 hours
($5.50  1,000)..........................................................................  5,500
Fixed cost........................................................................................ $   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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Managerial Accounting, 8/e 6- 45
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.

McGraw-Hill/Irwin  2009 The McGraw-Hill Companies,

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6-46 Solutions Manual
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 airline’s 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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Managerial Accounting, 8/e 6- 47
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................................................................... $14.00

Labor (.6 hr. @ $11/hr.).............................................................. 6.60
Variable overhead (.6 hr. @ $4/hr.)............................................. 2 .40
Total..................................................................................... $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................................................................... $14.00

Labor (.6 hr. @ $11/hr.).............................................................. 6.60
Variable overhead (.6 hr. @ $4/hr.)............................................. 2.40
Fixed overhead (.6 hr. @ $10/hr.)*.............................................. 6 .00
Total..................................................................................... $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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6-48 Solutions Manual
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 Dana’s 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 Dana’s 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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Managerial Accounting, 8/e 6- 49
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).

McGraw-Hill/Irwin  2009 The McGraw-Hill Companies,

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6-50 Solutions Manual
PROBLEM 6-46 (CONTINUED)

2. Estimation of variable- and fixed-cost 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.

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 + $677 X, 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 R 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.

Interpretation of R 2:

The coefficient of determination, R 2, is a measure of the goodness of fit of the

least-squares regression line. An R 2 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 R 2, the better the
regression line fits the data. The interpretation of a high R 2 is that the
independent variable is a good predictor of the behavior of the dependent
variable. In the county’s cost estimation, a high R 2 would mean that the
county budget officer can be relatively confident in the cost predictions based
on the estimated-cost behavior pattern. An R 2 of .58 is not particularly high.

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Managerial Accounting, 8/e 6- 51
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 Independent
Variable Variable
(cost in (flights in
thousands) hundreds)
Month Y X X2 XY
January................... 20 12 144 240
February.................. 19 10 100 190
March...................... 18 9 81 162
April......................... 19 14 196 266
May......................... 17 8 64 136
June........................ 20 11 121 220
July.........................  21  15   225   315
August..................... 17 9 81 153
September............... 21 12 144 252
October................... 19 10 100 190
November................ 24 14 196 336
December................ 18 11 121 198
Total........................ 233 135 1,573 2,658

(b) Calculation of parameters:

( Y )( X 2 )  (  X )( XY )
a =
n (  X 2 )  (  X )( X )
(233)(1,573)  (135)(2,658)
=  11.796 (rounded)
(12)(1,573)  (135)(135)

n(  XY)  (  X)(  Y)
b =
n(  X 2 )  (  X)(  X)
)  (135)(233)
(12)(2,658
= (12)(1,573  .677 (rounded)
)  (135)(135)

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6-52 Solutions Manual
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:

(Y  Y ') 2
R2  1
(Y Y ) 2

where Y 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.

Y denotes the mean (average) observation of the dependent

variable (cost).

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Managerial Accounting, 8/e 6- 53
PROBLEM 6-46 (CONTINUED)

(b) Tabulation of data:*

Predicted Cost
(in thousands)
Based on
Regression
Month Y X Line Y' [( Y– Y' ) 2] † [( Y – Y ) 2] †
January........ 20 12 19.920 .006 .340
February....... 19 10 18.566 .188 .174
March........... 18 9 17.889 .012 2.008
April............. 19 14 21.274 5.171 .174
May.............. 17 8 17.212 .045 5.842
June............. 20 11 19.243 .573 .340
July.............. 21 15 21.951   .904  2.506
August.......... 17 9 17.889 .790 5.842
September.... 21 12 19.920 1.166 2.506
October........ 19 10 18.566 .188 .174
November..... 24 14 21.274 7.431 21.004
December..... 18 11 19.243 1.545 2.008
Total............. 18.019 42.918

* Y' = ($11,796 + $677 X )/$1,000

Y =
 Y/12 = 233/12 = 19.417 (rounded)
†
Rounded.

(c) Calculation of R 2:

18.019
R2 = 1 – = .58 (rounded)
42.918

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6-54 Solutions Manual
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................................................................................ $390.00

Direct labor (5 DLH*  $11.00 per DLH)........................................... 55.00
Variable overhead (5 DLH  $9.25 per DLH)....................................   46.25
Total variable cost per 1,000 square feet.......................................... $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)......................................................... $19,500.00

Direct labor ($55.00  50)............................................................... 2,750.00
Variable overhead ($9.25 per DLH  5 DLH  50)............................. 2,312.50
Overtime premium ($5.50 per DLH  5 DLH  50  .3)..................... 412.50
Minimum bid................................................................................... $24,975.00

4. 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 OH 1 (50  5  $4.15)..........................................................$1,037.50

Variable OH 2 (50  $13.60).............................................................. 680.00
Variable OH 3 (70  $5.90)................................................................ 413.00
Total incremental variable overhead.................................................$2,130.50

b. Variable OH 1 (50  5  $4.15)..........................................................$1,037.50

Variable OH 2 (25  $13.60).............................................................. 340.00
Variable OH 3 (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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6-56 Solutions Manual
CASE 6-48 (45 MINUTES)
1. Scatter diagram:

Administrative cost

$25,00
0

$20,00
0
2.

Visually-
$15,00 fitted
0  curvilinear
cost line


$10,00  4.
 
0  Visually-fitted
semivariable
 cost line

$5,000


Patient load
500 1,000 1,500 2,000
3. Relevant range

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

4.

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Managerial Accounting, 8/e 6- 57
CASE 6-48 (CONTINUED)

5. Fixed cost = $7,000

$10,600 $7,000
Variable cost per patient   $3.00
1,200 0

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

7. Cost predictions using visually-fit cost lines :

Patient Cost
Load Prediction

750................
$9,300
5,500
350…….

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:

$16,100 $4,100
Variable administrative cost per patient =  $10
1,500 300

Total cost at 1,500 patients............................................................... $16,100

Variable cost at 1,500 patients..........................................................  15,000
Fixed cost per month........................................................................ $  1,100

Cost formula:

Total monthly administrative cost = $1,100 + $10 X , 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 + $7.81 X

(b) High-low method:

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

(c) Visual-fit method:

Total monthly administrative cost = $7,000 + $3.00 X

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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Managerial Accounting, 8/e 6- 59
 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 hospital’s 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 Independent
Variable Variable
(cost in (patients in
hundreds) hundreds)
Month Y X X2 XY
January................... 60 4 16 240
February.................. 70 5 25 350
March...................... 139 14 196 1,946
April......................... 92 9 81 828
May......................... 119 13 169 1,547
June........................ 100 10 100 1,000
July......................... 94 7 49 658
August..................... 41 3 9 123
September............... 102 11 121 1,122
October...................   161  15   225   2,415
November................ 83 6 36 498
December................ 111 12 144 1,332
Total........................ 1,172 109 1,171 12,059

(b) Calculation of parameters:

( Y )( X 2 )  (  X )( XY )
a =
n (  X 2 )  (  X )( X )
171)  (109)(12,0
(1,172)(1, 59)
=  26.707 (rounded)
)  (109)(109)
(12)(1,171

n(  XY)  (  X)(  Y)
b =
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 + $7.81 X , 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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