CHAPTER 3
DISCUSSION QUESTIONS
Q3-1. The total dollar amount of a fixed cost is con-
stant at different levels of activity within the
relevant range, but fixed cost per unit of
activ- ity varies. In contrast, the total amount
of a variable cost varies at different levels of
activ- ity, but the variable cost per unit
remains con- stant within the relevant range.
A semivariable cost contains both fixed and
variable ele- ments. Consequently, both total
semivariable cost and semivariable cost per
unit vary with changes in activity.
Q3-2. The relevant range is the range of activity
over which a fixed cost remains constant in
total or a variable cost remains constant per
unit of activity. The underlying assumptions
about the relationship of the activity and the
incurrence of cost change outside the rele-
vant range of activity. Consequently, the
amount of fixed cost or the variable cost rate
must be recomputed for activity above or
below the relevant range.
Q3-3. The fixed and variable components of a semi-
variable cost should be segregated in order
to plan, analyze, control, measure, and
evaluate costs at different levels of activity.
Separation of the fixed and variable
components of semi- variable cost is
necessary to:
(a) compute predetermined factory overhead
rates and analyze variances;
(b) prepare flexible budgets and analyze
vari- ances;
(c) analyze direct cost and the contribution
margin;
(d) determine the break-even point and ana-
lyze the effect of volume on cost and
profit;
(e) compute differential cost and make com-
parative cost analyses;
(f) maximize short-run profits and minimize
short-run costs;
(g) budget capital expenditures;
(h) analyze marketing profitability by territo-
ries, products, and customers.
Q3-4. The obvious advantage to using managerial
judgement to separate fixed and variable
3-1
costs is expediency, i.e., it requires less time
and is, therefore, less costly than the use of
any of the three computational methods. The
disadvantage is that the use of managerial
judgment to separate fixed and variable costs
often results in unreliable estimates of cost.
Cost behavior is not always readily apparent
from casual observation. As a consequence,
managers often err in determining whether a
cost is fixed or variable and frequently ignore
the possibility that some costs are semivari-
able.
Q3-5. The three computational methods available
for separating the fixed and variable compo-
nents of semivariable costs are: (1) the high
and low points method; (2) the statistical
scat- tergraph method; and (3) the method of
least squares.
Q3-6. The high and low points method has the
advantage of being simple to compute, but it
has the disadvantage of using only two data
points in the computation, thereby resulting in
a significant potential for bias and inaccuracy
in cost estimates. The scattergraph has the
advantage of using all of the available data,
but it has the disadvantage of determining
the fixed and variable components on the
basis of a line drawn by visual inspection
through a plot of the data, thereby resulting in
bias and inaccuracy in cost estimates. The
method of least squares has the advantage
of accu- rately describing a line through all
the avail- able data, thereby resulting in
unbiased estimates of the fixed and variable
elements of cost, but it has the increased
disadvantage of computational complexity.
Q3-7. The $200 in the equation, referred to as the
y intercept, is an estimate of the fixed portion
of indirect supplies cost. The $4 in the equa-
tion, referred to as the slope of the regres-
sion equation, is an estimate of the variable
cost associated with a unit change in
machine hours. These estimates may not be
perfectly accurate because they were derived
from a sample of data that may not be
entirely
3-2
representative of the universe population,
and because activities not included in the
regression equation may have some influ-
ence on the cost being predicted.
Q3-8. The coefficient of correlation, denoted r, is a
measure of the extent to which two variables
are related linearly. It is a measure of the
covariation of the dependent and independ-
ent variables, and its sign indicates whether
the independent variable has a positive or
negative relationship to the dependent vari-
able. The coefficient of determination is the
square of the coefficient of correlation and is
denoted r 2. The coefficient of determination
is a more easily interpreted measure of the
covariation than is the coefficient of correla-
tion, because it represents the percentage of
variation in the dependent variable explained
by the independent variable.
Q3-9. The standard error of the estimate is defined
as the standard deviation about the regres-
sion line. It is essentially a measure of the
variability of the actual observations of the
dependent variable from the points predicted
on the regression line. A small value for the
standard error of the estimate indicates a
Chapter 3
good fit. A standard error of zero would indi-
cate a perfect fit, i.e., all actual observations
would be on the regression fine.
Q3-10. Heteroscedasticity means that the distribution
of observations around the regression line is
not uniform for all values of the independent
variable. If heteroscedasticity is present, the
standard error of the estimate and confidence
interval estimates, based on the standard
error, are unreliable measures.
Q3-11. Serial correlation means that rather than
being random, the observations around the
regression line are correlated with one
another. If serial correlation is present, the
standard error of the estimate and
confidence interval estimates, based on the
standard error, are unreliable measures.
Q3-12. Multicollinearity means that two or more of
the independent variables in a multiple
regression analysis are correlated with one
another. When the degree of multicollinearity
is high, the relationship between one or more
of the correlated independent variables and
the dependent variable may be obscured.
However, this circumstance would normally
not affect the estimate of cost.
 EXERCISES

E3-1
Activity Level Cost

High................................................2,600 hours $1,300

Low.................................................2,100 1,100
Difference...................................... 500 hours $ 200

Variable rate: $200 ÷ 500 machine hours = $.40 per machine hour

High Low
Total cost ................................... $1,300 $1,100
Variable cost:
$.40 × 2,600 hours..............1,040
$.40 × 2,100 hours........ 840
Fixed cost .................................. $ 260 $ 260

E3-2

$1,000

$900

$800

$700
SUPPLIES COST

$600

$500

$400

$300

$200

$100

$0
0 200 400 600 800

DIRECT LABOR HOURS

Average cost ($7,575 total ÷ 10 months).........................$757.50

Fixed cost per month ................................................... 350.00
Average total variable cost.............................................. $407.50
$407.50 average total variable cost
5,875 total direct labor hours ÷ 10 months $.6936 variable cost
= per direct labor hour
 E3-3
b = Σ(x i − x )(yi − y ) = 87,000 = $60
Σ(xi − x )2 1,450
– –
a = y – bx = $10,000 – ($60 × 125) = $2,500
Travel and entertainment expense for 200 sales calls would be:
yi = a + bxi = $2,500 + ($60 × 200 calls) = $14,500

E3-4

(1) (2) (3) (4) (5) (6)

–
y (y – –y) x –
2 x – x )(y –
y
Electricity Cost Machine (x –– x )
Activity (x – x ) (
–
Month Cost Deviation Hours Deviation (4) Squared (4) × (2) )
January...... $1,600 100 2,790 190 36,100 19,000
February .... 1,510 10 2,680 80 6,400 800
March ......... 1,500 0 2,600 0 0 0
April ........... 1,450 (50) 2,500 (100) 10,000 5,000
May............. 1,460 (40) 2,510 (90) 8,100 3,600
June ........... 1,520 20 2,610 10 100 200
July ............ 1,570 70 2,750 150 22,500 10,500
August ....... 1,530 30 2,700 100 10,000 3,000
September . 1,480 (20) 2,530 (70) 4,900 1,400
October...... 1,470 (30) 2,520 (80) 6,400 2,400
November .. 1,450 (50) 2,490 (110) 12,100 5,500
December .. 1,460 (40) 2,520 (80) 6,400 3,200
Total $18,000 0 31,200 0 123,000 54,600

–
y = Σy = n = $18,000 ÷ 12 = $1,500
–
x = Σx = n = 31,200 ÷ 12 = 2,600
Variable rate (b ) = Σ(x − x )(y − y ) = Column 6 total = 54,600 = $.44
Σ(x − x )2 Column 5 total123,000
– –
Fixed cost (a) = y – bx
= $1,500 – ($.44)(2,600)
= $356
 E3-5

Σ(x i − x )(yi − 1,564

r= = = .92
y )
2
Σ(x i − x ) Σ(y − y (850) (3,400)
2
)
2 2
r = (.92) − .8464

E3-6

(1) (2) (3) (4) (5) (6) (7) 2

(y – –y) – – –
y x –2 x – x )(y – y) (y –
(x – x ) (x – x ) ( –
y )
Shipping Expense Sales Activity
Month Expense Deviations Revenue Deviations (4) Squared (4) × (2) (2) Squared
January .... $ 560 (40) $26,500 (3,500) 12,250,000 140,000 1,600
.
February.... 600 0 30,000 0 0 0 0
March ........ 600 0 29,000 (1,000) 1,000,000 0 0
April........... 580 (20) 28,000 (2,000) 4,000,000 40,000 400
May ........... 570 (30) 27,000 (3,000) 9,000,000 90,000 900
.
June........... 550 (50) 25,500 (4,500) 20,250,000 225,000 2,500
July ........... 590 (10) 30,000 0 0 0 100
.
August....... 610 10 33,000 3,000 9,000,000 30,000 100
September 650 50 35,000 5,000 25,000,000 250,000 2,500
October .... 620 20 32,000 2,000 4,000,000 40,000 400
.

y = Σy ÷ n = $7,200 ÷ 12 = $600
x = Σx ÷ n = $360,000 ÷ 12 = $30,000
Σ(x − x )(y − y ) 970,000
r= = = .939
2
Σ(x i − x ) Σ(y − y ) (97,000,000) (11,000)
2

2 2
r = (.939) = .882
E3-7

(1)
r= Σ(xi − x )(yi − y ) 2,400 = .96
2
=
Σ(x i − x ) Σ(y − y ) (6,250) (1,000)
2

2 2
r = (.96) = .9216

(2)
Σ(x i − x )(yi − y ) 2,400 variable maintenance
b= = = $.384
Σ(xi − x) 6,250 cost per machine hour
2

(3)
y = Σyi ÷ n = $50,000 ÷ 10 = $5,000
x = Σxi ÷ n = 40,000 ÷ 10 = 4,000 hours
Since y = a + bx , then :
a = y − bx
a = $5,000 − ($.384)(4,000)
a = $5,000 − $1,536
a= $3,464

E3-8

(1) For electricity cost and direct labor hours:

Σ(x i − x )(yi − y )
r= = 5,700 5,700
= = .9497
2
Σ(x i − x ) Σ(y − y ) (28,500) (1,264) 6,002
2

2 2
r = (.9497) = .9019

(2) For electricity cost and machine hours:

Σ(x i − x )(yi − y ) 7,000
r= = 7,000 = = .8805
2
Σ(x i − x ) Σ(y − y ) (50,000) (1,264) 7,950
2

2 2
r = (.8805) = .7753

(3) In this case, direct labor hours should be chosen as the appropriate activity
measure to be used in predicting electricity cost because the coefficient of
determination (r2 = .9019) is higher than that for machine hours (r2 = .7753).
 E3-8 (Concluded)

(4)
Σ(xi − x )(yi − 5,700 variable electricity
b)
y
= = = $.20
Σ(x −
2
x) 28,500 cost rate
i

Since y = a + bx and y = Σyi ÷ n and x = Σxi ÷ n, then :

a = (Σyi ÷ n) − b(Σx i ÷ n)
a = (42,000 ÷ 20) − (.20)(180,000 ÷ 20)
a = 2,100 − (.20)(9,000)
a= 2,100 − 1,800 = $300 fixed electricity cost

E3-9

(1) (2) (3) (4) (5)

xi yi (y′i = a + bxi) (yi – y′i) (yi – y′i)2
Actual Predicted Prediction
Labor Utility Utility Error (4)
Month Hours Cost Cost (2) – (3) Squared
January .................. 2,650 $ 3,600 $ 3,650 (50) $2,500
February ................ 3,000 4,000 4,000 0 0
March ..................... 2,900 4,000 3,900 100 10,000
April........................ 2,800 3,800 3,800 0 0
May ......................... 2,700 3,700 3,700 0 0
June........................ 2,550 3,500 3,550 (50) 2,500
July......................... 3,000 3,900 4,000 (100) 10,000
August.................... 3,300 4,100 4,300 (200) 40,000
September ............. 3,500 4,500 4,500 0 0
October .................. 3,200 4,200 4,200 0 0
November .............. 3,050 4,300 4,050 250 62,500
December .............. 3,350 4,400 4,350 50 2,500
Total.................... 36,000 $48,000 $48,000 0 $130,000

Σ(yii − y ′) 2 Column 5 total $130,000

s′= = = = $114.018
n− 2 12 − 2 10
E3-10

Σ(yii − y′) 2 $49,972

s′= = = 3,844 = $62
n− 2 15 − 2

The 90 percent confidence interval estimate at the 1,500-hour level of activity

would be:

1(x − x )2
y′i ± t 90% s′ 1+ +i
nΣ(x −i x )2

$500 ± (1.771) 1(1,500 − 1,300)2

($62) 1+ 15 +
150,000
$500 ± (1.771) 1.3333
($62)
$500 ± (1.771)($62) (1.1547)
$500 ± $126.79
 PROBLEMS

P3-1

(1) Coefficient of correlation and coefficient of determination between:

(a) Travel expenses and the number of calls made:

(1) (2) (3) (4) (5) (6) (7)

– – – – –
y (y – y ) x (x – x ) (x – x )2 (x – x )(y – y ) (y –
–
y )2 Travel Expense Calls Activity
Month Expense Deviations Made Deviations (4) Squared (4) × (2) (2) Squared
January............ $ 3,000 (200) 410 (30) 900 6,000 40,000
February .......... 3,200 0 420 (20) 400 0 0
March ............... 2,800 (400) 380 (60) 3,600 24,000 160,000
April ................. 3,400 200 460 20 400 4,000 40,000
May .................. 3,100 (100) 430 (10) 100 1,000 10,000
June ................. 3,200 0 450 10 100 0 0
July .................. 2,900 (300) 390 (50) 2,500 15,000 90,000
August ............. 3,300 100 470 30 900 3,000 10,000
September....... 3,500 300 480 40 1,600 12,000 90,000
October............ 3,400 200 490 50 2,500 10,000 40,000
November ........ 3,200 0 440 0 0 0 0
December ........ 3,400 200 460 20 400 4,000 40,000
Total $38,400 0 5,280 0 13,400 79,000 520,000

Σ(x i − x )(yi − y )
r= = Column 6 total
Σ(x − x ) 2
−y) (Column 5 total) (Column 7 total)
2
i Σ(y 79,000
r=
79,000 =
(13,400)(520,000) 6,968,000,000
79,000
r= = .9464
83,475
2
r = .8957
P3-1 (Concluded)

(b) Travel expenses and orders received:

(1) (2) (3) (4) (5) (6) (7)

– – – – –
y (y – y ) x (x – x ) (x – x )2 (x – x )(y – y ) (y –
–
y )2 Travel Expense Orders Activity
Month Expense Deviations Received Deviations (4) Squared (4) × (2) (2) Squared
January............ $ 3,000 (200) $53,000 (13,000) 169,000,000 2,600,000 40,000
February ......... 3,200 0 65,000 (1,000) 1,000,000 0 0
March ............... 2,800 (400) 48,000 (18,000) 324,000,000 7,200,000 160,000
April ................. 3,400 200 73,000 7,000 49,000,000 1,400,000 40,000
May .................. 3,100 (100) 62,000 (4,000) 16,000,000 400,000 10,000
June ................. 3,200 0 67,000 1,000 1,000,000 0 0
July .................. 2,900 (300) 60,000 (6,000) 36,000,000 1,800,000 90,000
August ............. 3,300 100 76,000 10,000 100,000,000 1,000,000 10,000
September....... 3,500 300 82,000 16,000 256,000,000 4,800,000 90,000
October............ 3,400 200 62,000 (4,000) 16,000,000 (800,000) 40,000
November ........ 3,200 0 64,000 (2,000) 4,000,000 0 0
December ........ 3,400 200 80,000 14,000 196,000,000 2,800,000 40,000
Total ............ $38,400 0 $792,000 0 1,168,000,000 21,200,000 520,000

Σ(x i − x )(yi − y ) Column 6 total

r= =
2
Σ(x i − x ) Σ(y − y ) (Column 5 total) (Column 7 total)
2

21,200,000
= = 21,200,000
(1,168,000,000)(520,000)
607,360,000,000,000
21,000,000
= = .8602
24,644,675
2
r = .7399

(2) Perfect direct correlation would be evidenced by a correlation coefficient of one.

The coefficient of .9464 revealed in (1)(a) is closer to one than the coefficient
of
.8602 in (1)(b). This means that the variable portion of travel expense varies
more directly with movements in the number of calls made than with the value
of orders received. To explain this further, the relative coefficients of
determination are obtained by squaring the coefficients of correlation and
expressing the answer as a percentage in each case. The coefficients of
determination are 89.57% for calls made and only 73.99% for orders received.
This means that approximately 90% of the movements in the variable portion of
travel expense are related to fluc- tuations in the number of calls made, and the
remaining 10% of the movements are related to other factors.
P3-2
(1)

(1) (2) (3) (4) (5) (6) (7)

– – – – –
y (y – y ) x (x – x ) (x – x )2 (x – x )(y – y ) (y –
–
y )2 Supplies Cost Labor Activity
Month Cost Deviations Hours Deviations (4) Squared (4) × (2) (2) Squared
January............ $ 1,505 5 5,000 0 0 0 25
February .......... 1,395 (105) 4,600 (400) 160,000 42,000 11,025
March ............... 1,565 65 5,160 160 25,600 10,400 4,225
April ................ 1,515 15 5,100 100 10,000 1,500 225
May .................. 1,445 (55) 4,830 (170) 28,900 9,350 3,025
June ................. 1,415 (85) 4,750 (250) 62,500 21,250 7,225
July .................. 1,465 (35) 4,900 (100) 10,000 3,500 1,225
August ............. 1,505 5 5,080 80 6,400 400 25
September....... 1,575 75 5,200 200 40,000 15,000 5,625
October............ 1,535 35 5,130 130 16,900 4,550 1,225
November ........ 1,500 0 4,950 (50) 2,500 0 0
December ........ 1,580 80 5,300 300 90,000 24,000 6,400
Total ............. $18,000 0 60,000 0 452,800 131,950 40,250

y = Σy ÷ n = $18,000 ÷ 12 = $1,500

x = Σx ÷ n = $60,000 ÷ 12 = $5,000

Σ(x − x )(y − y ) 131,950

r = Σ(x − x )2 Σ(y − y )2 = = .977
(452,800) (40,250)

2 2
r = (.977) = .955
P3-2 (Concluded)

(1) (2) (3) (4) (5) (6) (7)

– – – – –
y (y – y ) x (x – x ) (x – x )2 (x – x )(y – y ) (y –
–2
y ) Supplies Cost Machine Activity
Month Cost Deviations Hours Deviations (4) Squared (4) × (2) (2) Squared
January............ $ 1,505 5 2,000 (50) 2,500 (250) 25
February .......... 1,395 (105) 1,990 (60) 3,600 6,300 11,025
March ............... 1,565 65 2,140 90 8,100 5,850 4,225
April ................. 1,515 15 2,080 30 900 450 225
May .................. 1,445 (55) 1,960 (90) 8,100 4,950 3,025
June ................. 1,415 (85) 1,940 (110) 12,100 9,350 7,225
July .................. 1,465 (35) 2,020 (30) 900 1,050 1,225
August ............. 1,505 5 1,990 (60) 3,600 (300) 25
September....... 1,575 75 2,140 90 8,100 6,750 5,625
October............ 1,535 35 2,050 0 0 0 1,225
November ........ 1,500 0 2,030 (20) 400 0 0
December ........ 1,580 80 2,260 210 44,100 16,800 6,400 Total
............ $18,000 0 24,600 0 92,400 50,950 40,250

y = Σy ÷ n = $18,000 ÷ 12 = $1,500
x = Σx ÷ n = $24,600 ÷ 2,050
12 =
50,950
= .835
Σ(x − x )(y − y ) (92,400) (40,250)
r = Σ(x − x )2 Σ(y − y )2 =
2 2
r = (.835) = .697

(2) Since the coefficient of determination for supplies cost and labor hours (r 2 = .
955) is greater than the coefficient of determination for supplies cost and
machine hours (r 2 = .697), labor hours should be used as the basis for
estimating supplies cost. Labor hours explain more of the variance in supplies
cost than do machine hours.

(3) With labor hours as the basis for predicting supplies cost, the fixed cost and the
variable cost rate can be determined by the method of least squares as follows:

Σ(x − x )(y − y ) Column 6 total 131,950

Variable rate (b ) = =
Column 5 =
452,800 = $.29141
Σ(x − x )
2 total
Fixed cost (a)
= y − bx
= $1,500 − ($.29141)(5,000)
= $42.95
P3-3

(1) (2) (3) (4) (5) (6) (7)

– – – – –
y (y – y ) x (x – x ) (x – x )2 (x – x )(y – y ) (y –
–2
y ) Electricity Cost Labor Activity
Month Cost Deviations Hours Deviations (4) Squared (4) × (2) (2) Squared
January............ $1,600 20 4,200 (30) 900 (600) 400
February .......... 1,570 (10) 4,000 (230) 52,900 2,300 100
March ............... 1,610 30 4,360 130 16,900 3,900 900
April ................. 1,550 (30) 4,000 (230) 52,900 6,900 900
May .................. 1,530 (50) 4,050 (180) 32,400 9,000 2,500
June ................. 1,540 (40) 4,100 (130) 16,900 5,200 1,600
July .................. 1,520 (60) 4,150 (80) 6,400 4,800 3,600
August ............. 1,530 (50) 4,250 20 400 (1,000) 2,500
September....... 1,580 0 4,150 (80) 6,400 0 0
October............ 1,650 70 4,500 270 72,900 18,900 4,900
November ........ 1,660 80 4,600 370 136,900 29,600 6,400
December ........ 1,620 40 4,400 170 28,900 6,800
1,600 Total ............. $18,960 0 50,760 0 424,800 85,800 25,400

y = Σy ÷ n = $18,960 ÷ 12 = $1,580

x = Σx ÷ n = $50,760 ÷ 12 = 4,230

Σ(x − x )(y − y ) 85,800

r = Σ(x − x )2 Σ(y − y )2 = = .826
(424,800) (25,400)
2 2
r = (.826) = .682
P3-3 (Concluded)

(1) (2) (3) (4) (5) (6) (7)

– – –2 – –
y (y – y ) x (x – x ) (x – x ) (x – x )(y – y ) (y –
–2
y ) Electricity Cost Machine Activity
Month Cost Deviations Hours Deviations (4) Squared (4) × (2) (2) Squared
January............ $1,600 20 2,300 0 0 0 400
February .......... 1,570 (10) 2,150 (150) 22,500 1,500 100
March .............. 1,610 30 2,400 100 10,000 3,000 900
April ................. 1,550 (30) 2,250 (50) 2,500 1,500 900
May .................. 1,530 (50) 2,160 (140) 19,600 7,000 2,500
June ................. 1,540 (40) 2,240 (60) 3,600 2,400 1,600
July .................. 1,520 (60) 2,180 (120) 14,400 7,200 3,600
August ............ 1,530 (50) 2,170 (130) 16,900 6,500 2,500
September....... 1,580 0 2,260 (40) 1,600 0 0
October............ 1,650 70 2,500 200 40,000 14,000 4,900
November ........ 1,660 80 2,540 240 57,600 19,200 6,400
December ........ 1,620 40 2,450 150 22,500 6,000
1,600 Total ........... $18,960 0 27,600 0 211,200 68,300 25,400

y = Σy ÷ n = $18,960 ÷ 12 = $1,580

x = Σx ÷ n = $27,600 ÷ 12 = 2,300

Σ(x − x )(y − y ) 68,300

r = Σ(x − x )2 Σ(y − y )2 = = .933
(211,200) (25,400)
2 2
r = (.933) = .870

(2) Since the coefficient of determination for electricity cost and machine hours
(r2 = .870) is greater than the coefficient of determination for electricity cost
and labor hours (r2 = .682), machine hours should be used as the basis for
estimating electricity cost. Machine hours explain more of the variance in
electricity cost than do labor hours.

(3) With machine hours as the basis for predicting electricity cost, the fixed cost
and the variable cost rate can be determined by the method of least squares
as follows:
Σ(x − x )(y − y ) Column 6 total
68,300
Variable rate (b ) = = = = $.32339
Σ(x
2
−x) Column 5 211,200
total
Fixed cost (a)
= y − bx
= $1,580 − ($.32339)(2,300)
= $836.20
 P3-4

(1)
Maintenance Machine
Cost Hours
High ................................................................. $2,290 2,700
Low .................................................................. 2,000 2,000
Difference........................................................ $ 290 700

Variable rate = $290 ÷ 700 hours = $.4142857 per machine hour

High Low
Total cost ........................................................ $2,290.00 $2,000.00
Total variable cost .......................................... 1,118.57 828.57
Average fixed cost ......................................... $1,171.43 $1,171.43

(2) (1) (2) (3) (4) (5) (6) (7)

– – – – – –
yi (yi – y ) xi (xi – x ) (xi – x )2 (xi – x )(yi – y ) (yi – y )
2

Maintenance Cost Machine Activity

Month Cost Deviations Hours Deviations (4) Squared (4) × (2) (2) Squared
January............ $2,200 40 2,500 100 10,000 4,000 1,600
February .......... 2,130 (30) 2,350 (50) 2,500 1,500 900
March ............... 2,000 (160) 2,000 (400) 160,000 64,000 25,600
April ................. 2,170 10 2,400 0 0 0 100
May .................. 2,050 (110) 2,100 (300) 90,000 33,000 12,100
June ................. 2,220 60 2,600 200 40,000 12,000 3,600
July .................. 2,150 (10) 2,450 50 2,500 (500) 100
August ............. 2,250 90 2,550 150 22,500 13,500 8,100
September....... 2,290 130 2,700 300 90,000 39,000 16,900
October............ 2,150 (10) 2,450 50 2,500 (500) 100
November ........ 2,210 50 2,400 0 0 0 2,500
December ........ 2,100 (60) 2,300 (100) 10,000 6,000 3,600
Total ........... $25,920 0 28,800 0 430,000 172,000 75,200
y = Σyi ÷ n = $25,920 ÷ 12 = $2,160
x = Σxi ÷ n = $28,800 ÷ 12 = 2,400
Σ(x − x )(y − y ) Column 6 total 172,000
b= 2 =
Column 5 =
430,000 = $.40 variable cost rate
Σ(x − x ) total
Since y = a + bx , then :
a = y − bx
a = $2,160 − ($.40)(2,400)
a = $2,160 − $960
a= $1,200
 P3-4 (Concluded)

(3)
r = Σ(x − x )(y − y )= Column 6 total
Σ(xi − x )2 Σ(y i− y )2 (Column 5 total) (Column 7 total)
172,000
172,000 172,000
r= =
(430,000)(75,200)32,336,000,000 == .9565
179,822
r 2 = (.9565)2 = .91489
(4) (1) (2) (3) (4) (5)
xi yi (y′i = a + bxi) (yi – y′i) (yi – y′i)2
Prediction Actual Predicted
Machine Maintenance Maintenance Error (4)
Month Hours Cost Cost (2) – (3) Squared
January .................. 2,500 $2,200 $2,200 $0 $0
February ................ 2,350 2,130 2,140 (10) 100
March ..................... 2,000 2,000 2,000 0 0
April........................ 2,400 2,170 2,160 10 100
May ......................... 2,100 2,050 2,040 10 100
June........................ 2,600 2,220 2,240 (20) 400
July......................... 2,450 2,150 2,180 (30) 900
August.................... 2,550 2,250 2,220 30 900
September ............. 2,700 2,290 2,280 10 100
October .................. 2,450 2,150 2,180 (30) 900
November .............. 2,400 2,210 2,160 50 2,500
December .............. 2,300 2,100 2,120 (20) 400
Total.................... 28,800 $25,920 $25,920 $0 $6,400

Σ(yii − y′) 2 Column 5 total $6,400

s′= = = = $25.29822
n− 2 12 − 2 10

(5) The 95% confidence interval for maintenance cost at the 2,500 machine hour
level of activity is

1(x − x )2
y′ ± t95% s′ 1+ +i
nΣ(x −i x )2
1(2,500 − 2,400)2
$1,200 + ($.40)(2,500) ± (2.228)(25.29822) 1+ 12 +
430,000
$2,200 ± $59.29
P3-5

(1) (a) The method of least squares:

(1) (2) (3) (4) (5) (6) (7)

– – – – – –
yi (yi – y ) xi (xi – x ) (xi – x )2 (xi – x )(yi – y ) (yi – y )2
Difference Difference
from from
Average of Average of (2)
$700 3,500 (4) Squared (4) × (2) Squared
Electricity Electricity Guest Guest (000s (000s (000s
Month Cost Cost Days Days omitted) omitted) omitted)
January............ $ 400 $(300) 1,000 (2,500) 6,250 $ 750 $ 90
February .......... 500 (200) 1,500 (2,000) 4,000 400 40
March ............... 500 (200) 2,500 (1,000) 1,000 200 40
April ................. 700 0 3,000 (500) 250 0 0
May .................. 600 (100) 2,500 (1,000) 1,000 100 10
June ................. 800 100 4,500 1,000 1,000 100 10
July .................. 1,000 300 6,500 3,000 9,000 900 90
August ............. 900 200 6,000 2,500 6,250 500 40
September....... 900 200 5,500 2,000 4,000 400 40
October............ 700 0 3,000 (500) 250 0 0
November ........ 600 (100) 2,500 (1,000) 1,000 100 10
December ........ 800 100 3,500 0 0 0 10
Total ........... $8,400 0 42,000 0 34,000 $3,450 $380

Σ(xi − x )(yi − y ) Column 6 total $3,450

b= = Column 5 total =34,000 = $.1015 variable rate
Σ(xi −
2
x)

Since y = a + bx , then:
$700 = a + ($.1015 × 3,500)
a = $700 − $355
a = $345 fixed cost per month
P3-5 (Continued)
(b) The high and low points method:
Electricity Guest
Cost Days
High ............................................................ $1,000 6,500
Low............................................................. 400 1,000
Difference .................................................. $ 600 5,500
$600
Variable rate = = $.1091per guest day
5,500
Fixed cost = $1,000 − (6,500 × $.1091)
= $1,000 − $709
= $291
OR
Fixed cost = $400 − (1,000 × $.1091)
= $400 − $109
= $291
(c) A scattergraph with trend line fitted by inspection:
$1,100

$1,000 July
ELECTRICITY COST PER MONTH

Dec. Sept. Aug.

$900
June
$800
Apr. & Oct.

$700
May & Nov.
$500
$600 Feb. Mar.

$400 Jan. Approx. $350

$300

$200

$100
0 1,000 2,000 3,000 4,000 5,000 6,000 7,000
$0
GUEST DAYS PER MONTH
Fixed cost per month
determined = $.10 variable cost
$350 by inspection....... per guest day
$350 3,500 average guest days
Average cost................$700
Less fixed cost............ 350
Variable cost............... $350
P3-5 (Continued)

(2) The coefficient of correlation (r) and the coefficient of determination (r2), using
data from the requirement (1)(a) answer:

Σ(xi − x )(yi − y ) Column 6 total

r = Σ(x − x ) Σ(y − y ) = (Column 5 total) (Column 7 total)
2 2

3,450,000 3,450,000
r = (34,000,000)(380,000) =
12,920,000,000,000
3,450,000
= = .9598
3,594,440
2
r = .9212

(3) The standard error of the estimate:

(1) (2) (3) (4) (5)

xi yi (y′i = a + bxi) (yi – y′i) (yi – y′i)2
Prediction
Error
Actual Predicted Prediction Squared
Guest Electricity Electricity Error (4)
Month Days Cost Cost (2) – (3) Squared
January .................. 1,000 $ 400 $ 447 $(47) $ 2,209
February ................ 1,500 500 497 3 9
March ..................... 2,500 500 599 (99) 9,801
April........................ 3,000 700 650 50 2,500
May ......................... 2,500 600 599 1 1
June........................ 4,500 800 802 (2) 4
July ........................ 6,500 1,000 1,005 (5) 25
August.................... 6,000 900 954 (54) 2,916
September ............. 5,500 900 903 (3) 9
October .................. 3,000 700 650 50 2,500
November .............. 2,500 600 599 1 1
December .............. 3,500 800 700 100 10,000
Total.................... 42,000 $8,400 $8,405* $ (5)* $29,975
*rounding error

Σ(yii − y′) 2 Column 5 total $29,975

s′= = = = $2,997.5 = $54.75
n− 2 12 − 2 10
P3-5 (Concluded)

(4) The 90% confidence interval for electricity cost at 2,000 guest days would be:

y′i ± t 90% s′ 1+ 1(x − x )2

+i
nΣ(x −i x )2
1 2
($345 + ($.1015)(2,000)) ± (1.812) 1+ + (2,000 − 3,500)
($54.75) 12 34,000,000
$548± (1.812)($54.75)(1.072)
$548 ± $106.35

P3-6

(1) (a) The high and low points method:

Cost Activity
High ................................................................ $500 2,400
Low ................................................................. 400 1,400
Difference ....................................................... $100 1,000
Variable rate = $100 ÷ 1,000 Billets = $.10

Fixed cost = $500 – ($.10 × 2,400 Billets) = $260

or
Fixed cost = $400 – ($.10 × 1,400 Billets) = $260
P3-6 (Continued)

(b) A scattergraph with a trend line fitted by inspection:

$500

$400

$300
ELECTRICITY

$200

$100

$0
0 500 1,000 1,500 2,000 2,500

BILLETS

Fixed cost determined by inspection = $260

Average cost = $5,520 total cost ÷ 12 months = $460
Average activity = 24,000 total Billets ÷ 12 months = 2,000
Variable cost = ($460 average cost – $260 fixed cost) ÷ 2,000 average
activity = $.10 per Billet
 P3-6 (Continued)
(c)

(1) (2) (3) (4) (5) (6) (7)

– – – – –
y (y – y ) x (x – x ) (x – x )2 (x – x )(y – (y – y )2
Electricity Cost Number Activity (4) – (2)
y )
Month Cost Deviations of Billets Deviation Squared Squared
s (4) × (2)
January............ $ 455 (5) 2,000 0 0 0 25
February .......... 450 (10) 1,800 (200) 40,000 2,000 100
March ............... 435 (25) 1,900 (100) 10,000 2,500 625
April ................. 485 25 2,200 200 40,000 5,000 625
May .................. 470 10 2,100 100 10,000 1,000 100
June ................. 475 15 2,000 0 0 0 225
July .................. 400 (60) 1,400 (600) 360,000 36,000 3,600
August ............. 450 (10) 1,900 (100) 10,000 1,000 100
September....... 435 (25) 1,800 (200) 40,000 5,000 625
October............ 500 40 2,400 400 160,000 16,000 1,600
November ........ 495 35 2,300 300 90,000 10,500 1,225
December ........ 470 10 2,200 200 40,000 2,000 100
–
y = Σy ÷ n = $5,520 ÷ 12 = $460
–
x = Σx ÷ n = 24,000 ÷ 12 = 2,000

Σ(x − x )(y − y ) Column 6 total 81,000

Variable rate (b ) = =
Column =
5 total 800,000 = $.10125
Σ(x
2 −x)
Fixed cost (a)
= y − bx
= $460 − ($.10125)(2,000)
= $257.50

(2) The coefficient of correlation (r) and the coefficient of determination (r2), using
data from the answer in requirement (1)(c) follow:

Σ(xi − x )(yi − y ) 81,000

r= = = .957
2
Σ(x i − x ) Σ(y − y ) (800,000) (8,950)
2

2 2
r = (.957) = .916
P3-6 (Concluded)

(3)
(1) (2) (3) (4) (5)
y x (y′= a + bx) (y– y′ ) (y – y′ )2
Actual Number Estimated
Electricity of Electricity (4)
Month Cost Billets Cost (1) – (3) Squared
January .................. $ 455 2,000 $ 460 (5) 25
February ................ 450 1,800 440 10 100
March ..................... 435 1,900 450 (15) 225
April........................ 485 2,200 480 5 25
May ......................... 470 2,100 470 0 0
June........................ 475 2,000 460 15 225
July......................... 400 1,400 399 1 1
August.................... 450 1,900 450 0 0
September ............. 435 1,800 440 (5) 25
October .................. 500 2,400 501 (1) 1
November .............. 495 2,300 490 5 25
December .............. 470 2,200 480 (10) 100
Total.................... $5,520 24,000 $5,520 0 752

Σ(y − y′) 2 Column 5 total $752

s′= n− 2 = = = $8.672
12 − 2 10

The 95% confidence interval for electricity costs at the 2,200 Billets level of
activity would be determined as follows:

1( x − x ) 2
a + bx ± t s′ 1+ n +
95% Σ( x − x ) 2
2
1 (2,200 − 2,000)
$257.50 + ($.10125)(2,200) ± (2.228)($8.672) 1+ + 800,000
12
$480.25 ± (2.228)($8.672)(1.065)
$480.25 ± $20.58
or between a low of $459.67 and a high of $500.83.
P3-7
(1)
(1) (2) (3) (4) – (5)– (6) (7)
–
– – –
yi (yi – y) xi (xi – x ) (xi – x )2 (xi – x )(yi – y) (yi – y )2
Difference Difference
Factory from Direct from Average
Overhead Average Labor of 1,800 (4) (2)
Month Cost of $7,900 Hours Hours Squared (4) × (2) Squared
20A
Jan ................... $8,500 600 2,000 200 40,000 120,000 360,000
Feb .................. 9,900 2,000 2,400 600 360,000 1,200,000 4,000,000
.
Mar .................. 8,950 1,050 2,200 400 160,000 420,000 1,102,500
.
Apr ................... 9,000 1,100 2,300 500 250,000 550,000 1,210,000
May .................. 8,150 250 2,000 200 40,000 50,000 62,500
June ................ 7,550 (350) 1,900 100 10,000 (35,000) 122,500
.
July .................. 7,050 (850) 1,400 (400) 160,000 340,000 722,500
Aug................... 6,450 (1,450) 1,000 (800) 640,000 1,160,000 2,102,500
Sep................... 6,900 (1,000) 1,200 (600) 360,000 600,000 1,000,000
Oct ................... 7,500 (400) 1,700 (100) 10,000 40,000 160,000
Nov................... 7,150 (750) 1,600 (200) 40,000 150,000 562,500
Dec................... 7,800 (100) 1,900 100 10,000 (10,000) 10,000
20B
Jan ................... 8,700 800 2,100 300 90,000 240,000 640,000
Feb .................. 9,300 1,400 2,300 500 250,000 700,000 1,960,000
.
Mar .................. 9,300 1,400 2,200 400 160,000 560,000 1,960,000
.
Apr ................... 8,700 800 2,200 400 160,000 320,000 640,000
May .................. 8,000 100 2,000 200 40,000 20,000 10,000
June ................ 7,650 (250) 1,800 0 0 0 62,500
.
July .................. 6,750 (1,150) 1,200 (600) 360,000 690,000 1,322,500
Aug................... 7,100 (800) 1,300 (500) 250,000 400,000 640,000
Sep................... 7,350 (550) 1,500 (300) 90,000 165,000 302,500
Oct ................... 7,250 (650) 1,700 (100) 10,000 65,000 422,500
Nov................... 7,100 (800) 1,500 (300) 90,000 240,000 640,000
Dec................... 7,500 (400) 1,800 0 0 0 160,000
20C
Jan ................... 8,600 700 2,000 200 40,000 140,000 490,000
Feb .................. 9,300 1,400 2,300 500 250,000 700,000 1,960,000
.
Mar .................. 9,400 1,500 2,300 500 250,000 750,000 2,250,000
.
Apr. .................. 8,700 800 2,200 400 160,000 320,000 640,000
May .................. 8,100 200 2,000 200 40,000 40,000 40,000
June ................ 7,600 (300) 1,800 0 0 0 90,000
.
July .................. 7,000 (900) 1,300 (500) 250,000 450,000 810,000
Aug................... 6,900 (1,000) 1,200 (600) 360,000 600,000 1,000,000
Sep................... 7,100 (800) 1,300 (500) 250,000 400,000 640,000
Oct ................... 7,500 (400) 1,800 0 0 0 160,000
Nov................... 7,000 (900) 1,500 (300) 90,000 270,000 810,000
Dec................... 7,600 (300) 1,900 100 10,000 (30,000) 90,000
Total ................. $284,400 0 64,800 0 5,280,000 11,625,000 29,155,000
P3-7 (Continued)

Σ(xi − x )(yi − y ) Column 6 total 11,625,000

b= =Column 5 total =5,280,000 = $2.20 variable cost rate
Σ(xi −
2
x)

Since y = a + bx and y = Σyi ÷ n and x = Σxi ÷ n,

then : ($284,400 ÷ 36) = a + ($2.20)(64,800 ÷
36)
$7,900 = a + $3,960
a = $3,940 fixed overhead cost

(2) The coefficient of correlation and the coefficient of determination, using data
from the requirement (1) answer:

Σ(xi − x )(yi − y ) Column 6 total

r = =
2
Σ(x i − x ) Σ(y − y ) (Column 5 total) (Column 7 total)
2

11,625,000 11,625,000 11,625,000

r = (5,280,000)(29,155,000) = = = .9370
153,938,400,000,000 12,407,191
2 2
r = (.9370) = .8780
P3-7 (Continued)
(3) The standard error of the estimate:
(1) (2) (3) (4) (5)
xi yi (y′i = a + bxi) (y′i – yi) (y′i – yi)2
Actual Predicted Prediction
Direct Factory Factory Prediction Error
Labor Overhead Overhead Error Squared
Month Hours Cost Cost (2) – (3) (4) Squared
20A
January .................. 2,000 $ 8,500 $ 8,340 $160 $ 25,600
February ................ 2,400 9,900 9,220 680 462,400
March ..................... 2,200 8,950 8,780 170 28,900
April ....................... 2,300 9,000 9,000 0 0
May......................... 2,000 8,150 8,340 (190) 36,100
June ....................... 1,900 7,550 8,120 (570) 324,900
July......................... 1,400 7,050 7,020 30 900
August ................... 1,000 6,450 6,140 310 96,100
September ............. 1,200 6,900 6,580 320 102,400
October .................. 1,700 7,500 7,680 (180) 32,400
November .............. 1,600 7,150 7,460 (310) 96,100
December .............. 1,900 7,800 8,120 (320) 102,400
20B
January .................. 2,100 8,700 8,560 140 19,600
February ................ 2,300 9,300 9,000 300 90,000
March ..................... 2,200 9,300 8,780 520 270,400
April ....................... 2,200 8,700 8,780 (80) 6,400
May......................... 2,000 8,000 8,340 (340) 115,600
June ....................... 1,800 7,650 7,900 (250) 62,500
July......................... 1,200 6,750 6,580 170 28,900
August ................... 1,300 7,100 6,800 300 90,000
September ............. 1,500 7,350 7,240 110 12,100
October .................. 1,700 7,250 7,680 (430) 184,900
November .............. 1,500 7,100 7,240 (140) 19,600
December .............. 1,800 7,500 7,900 (400) 160,000
20C
January .................. 2,000 8,600 8,340 260 67,600
February ................ 2,300 9,300 9,000 300 90,000
March ..................... 2,300 9,400 9,000 400 160,000
April ....................... 2,200 8,700 8,780 (80) 6,400
May......................... 2,000 8,100 8,340 (240) 57,600
June ....................... 1,800 7,600 7,900 (300) 90,000
July......................... 1,300 7,000 6,800 200 40,000
August ................... 1,200 6,900 6,580 320 102,400
September ............. 1,300 7,100 6,800 300 90,000
October .................. 1,800 7,500 7,900 (400) 160,000
November .............. 1,500 7,000 7,240 (240) 57,600
December .............. 1,900 7,600 8,120 (520) 270,400
Total.................... 64,800 $284,400 $284,400 0 $3,560,200
P3-7 (Concluded)

Σ(yii − y′) 2 Column 5 total $3,560,200

s′= = = = $104,712 = $324
n− 2 36 − 2 34

(4) Since a large sample is used in this problem, t95% = z95% and the confidence
interval is:
y′i ± z95% s′
($3,940 + ($2.20)(2,200)) ± (1.960)($324)
$8,780 ± $635
P3-8

(1)

(1) (2) (3) (4) (5) (6) (7)

– – – – – –
yi (yi – y ) xi (xi – x ) (xi – x )2 (xi – x )(yi – y ) (yi – y )2
Maintenance Cost Labor Activity (4) (2)
Months Cost Deviation Hours Deviation Squared (4) × (2) Squared
Jan., 20A.......... $ 1,195 (286) 950 (290) 84,100 82,940 81,796
Feb., 20A ......... 1,116 (365) 1,024 (216) 46,656 78,840 133,225
Mar., 20A.......... 1,390 (91) 1,109 (131) 17,161 11,921 8,281
Apr., 20A .......... 1,449 (32) 1,148 (92) 8,464 2,944 1,024
May, 20A .......... 1,618 137 1,313 73 5,329 10,001 18,769
June, 20A ........ 1,525 44 1,261 21 441 924 1,936
July, 20A .......... 1,687 206 1,552 312 97,344 64,272 42,436
Aug., 20A ......... 1,650 169 1,372 132 17,424 22,308 28,561
Sep., 20A ......... 1,595 114 1,366 126 15,876 14,364 12,996
Oct., 20A .......... 1,675 194 1,455 215 46,225 41,710 37,636
Nov., 20A ......... 1,405 (76) 1,221 (19) 361 1,444 5,776
Dec., 20A ......... 1,251 (230) 1,150 (90) 8,100 20,700 52,900
Jan., 20B.......... 950 (531) 999 (241) 58,081 127,971 281,961
Feb., 20B ......... 1,175 (306) 1,022 (218) 47,524 66,708 93,636
Mar., 20B.......... 1,425 (56) 1,220 (20) 400 1,120 3,136
Apr., 20B .......... 1,506 25 1,283 43 1,849 1,075 625
May, 20B .......... 1,608 127 1,339 99 9,801 12,573 16,129
June, 20B ........ 1,653 172 1,250 10 100 1,720 29,584
July, 20B .......... 1,675 194 1,440 200 40,000 38,800 37,636
Aug., 20B ......... 1,724 243 1,290 50 2,500 12,150 59,049
Sep., 20B ......... 1,626 145 1,335 95 9,025 13,775 21,025
Oct., 20B .......... 1,575 94 1,164 (76) 5,776 (7,144) 8,836
Nov., 20B ......... 1,653 172 1,373 133 17,689 22,876 29,584
Dec., 20B ......... 1,418 (63) 1,124 (116) 13,456 7,308 3,969
Total ............ $35,544 0 29,760 0 553,682 651,300 1,010,506
–
y = Σyi ÷ n = $35,544 ÷ 24 = $1,481
–
x = Σxi ÷ n = 29,760 ÷ 24 = 1,240

Σ(xi − x )(yi − y )
r = = Column 6 total
2
Σ(x i − x ) Σ(y − y ) (Column 5 total) (Column 7 total)
2

651,300 651,300 651,300

= = = = .870725
(553,682)(1,010,506) 559,498,983,092 747,997
2 2
r = (.870725) = .758162
P3-8 (Continued)

(1) (2) (3) (4) (5) (6) (7)

– – – – – –
yi (yi – y ) xi (xi – x ) (xi – x )2 (x – x )(y – y ) (yi – y )2
Maintenance Cost Machine Activity (4) (2)
Months Cost Deviation Hours Deviation Squared (4) × (2) Squared
Jan., 20A.......... $1,195 (286) 809 (266) 70,756 76,076 81,796
Feb., 20A ......... 1,116 (365) 744 (331) 109,561 120,815 133,225
Mar., 20A.......... 1,390 (91) 987 (88) 7,744 8,008 8,281
Apr., 20A .......... 1,449 (32) 987 (88) 7,744 2,816 1,024
May, 20A .......... 1,618 137 1,186 111 12,321 15,207 18,769
June, 20A ........ 1,525 44 1,154 79 6,241 3,476 1,936
July, 20A .......... 1,687 206 1,291 216 46,656 44,496 42,436
Aug., 20A ......... 1,650 169 1,238 163 26,569 27,547 28,561
Sep., 20A ......... 1,595 114 1,186 111 12,321 12,654 12,996
Oct., 20A .......... 1,675 194 1,246 171 29,241 33,174 37,636
Nov., 20A ......... 1,405 (76) 997 (78) 6,084 5,928 5,776
Dec., 20A ......... 1,251 (230) 841 (234) 54,756 53,820 52,900
Jan., 20B.......... 950 (531) 502 (573) 328,329 304,263 281,961
Feb., 20B ......... 1,175 (306) 733 (342) 116,964 104,652 93,636
Mar., 20B.......... 1,425 (56) 1,090 15 225 (840) 3,136
Apr., 20B .......... 1,506 25 1,135 60 3,600 1,500 625
May, 20B .......... 1,608 127 1,174 99 9,801 12,573 16,129
June, 20B ........ 1,653 172 1,246 171 29,241 29,412 29,584
July, 20B .......... 1,675 194 1,264 189 35,721 36,666 37,636
Aug., 20B ......... 1,724 243 1,323 248 61,504 60,264 59,049
Sep., 20B ......... 1,626 145 1,230 155 24,025 22,475 21,025
Oct., 20B .......... 1,575 94 1,165 90 8,100 8,460 8,836
Nov., 20B ......... 1,653 172 1,237 162 26,244 27,864 29,584
Dec., 20B ......... 1,418 (63) 1,035 (40) 1,600 2,520 3,969
Total ............. $35,544 0 25,800 0 1,035,348 1,013,826 1,010,506
–
y = Σyi ÷ n = $35,544 ÷ 24 = $1,481
–
x = Σxi ÷ n = 25,800 ÷ 24 = 1,075

Σ(xi − x )(yi − y )
r = = Column 6 total
2
Σ(x i − x ) Σ(y − y ) (Column 5 total) (Column 7 total)
2

1,013,826 1,013,826 1,013,826

= = = = .991176
(1,035,348)(1,010,506) 1,046,225,366,088 1,022,852
2 2
r = (.991176) = .982430
 P3-8 (Continued)
(2) The activity measure used to predict maintenance expense should be machine
hours, which will result in the following cost estimates:

Σ(x − x )(y − y ) Column 6 total 1,013,826

b= = =
Column 5 total 1,035,348 = $.979213 variable rate
Σ(x
2 −x)

Since y = a + bx , then the estimated fixed cost is determined as follows:

a = y − bx
a = $1,481− ($.979213)(1,075)
a = $1,481− $1,052.65
a = $428.35
(3) (1) (2) (3) (4) (5)
xi yi (y′i = a + bxi) (yi – y′i) (yi – y′i)2
Actual Predicted Prediction
Machine Maintenance Maintenance Error (4)
Months Hours Cost Cost (2) – (3) Squared
Jan., 20A ................ 809 $ 1,195 $ 1,221 $(26) $ 676
Feb., 20A ................ 744 1,116 1,157 (41) 1,681
Mar., 20A ................ 987 1,390 1,395 (5) 25
Apr., 20A ................ 987 1,449 1,395 54 2,916
May, 20A................. 1,186 1,618 1,590 28 784
June, 20A ............... 1,154 1,525 1,558 (33) 1,089
July, 20A................. 1,291 1,687 1,693 (6) 36
Aug., 20A ............... 1,238 1,650 1,641 9 81
Sep., 20A................ 1,186 1,595 1,590 5 25
Oct., 20A ................ 1,246 1,675 1,648 27 729
Nov., 20A ................ 997 1,405 1,405 0 0
Dec., 20A................ 841 1,251 1,252 (1) 1
Jan., 20B ................ 502 950 920 30 900
Feb., 20B ................ 733 1,175 1,146 29 841
Mar., 20B ................ 1,090 1,425 1,496 (71) 5,041
Apr., 20B ................ 1,135 1,506 1,540 (34) 1,156
May, 20B................. 1,174 1,608 1,578 30 900
June, 20B ............... 1,246 1,653 1,648 5 25
July, 20B................. 1,264 1,675 1,666 9 81
Aug., 20B ............... 1,323 1,724 1,724 0 0
Sep., 20B................ 1,230 1,626 1,633 (7) 49
Oct., 20B ................ 1,165 1,575 1,569 6 36
Nov., 20B ................ 1,237 1,653 1,640 13 169
Dec., 20B................ 1,035 1,418 1,442 (24) 576
Total.................... 25,800 $35,544 $35,547* $ (3)* $17,817
*rounding error

Σ(yi − y′) 2 Column 5 total $17,817

s′= = = = $28.458103
n− 2 24 − 2 22
P3-8 (Concluded)

(4) The 95% confidence interval for maintenance cost at the 1,100 machine hour
level of activity is:

1 (x − x )2
y′i ± t 95% s′ 1+ + ii
nΣ(x − x )2
1 (1,100 − 1,075)2
$428.35 + ($.979213)(1,100) ± (2.074)(28.458103) 1+ 24 +
1,035,348
$1,505.48 ± $60.26
 CASES
C3-1

(1) W = a + bS
= 5.062 + (.023) (1,200)
= 5.062 + 27.6
= 32.662 or about 33 total workers

Total workers needed .......................................................... 33

Less permanent workers........................................................... 10
Number of temporary workers needed.................................... 23
(2) Regression 2 appears to be better than Regression 1 because:
(a) Data outside the relevant range have been excluded, thereby removing
any bias.
(b) The standard error of the estimate (s′) for Regression 2 is smaller than
the standard error of the estimate for Regression 1 (.432 compared to
2.012).
(c) The coefficient of determination (r 2) is higher for Regression 2 than the
coefficient of determination for Regression 1 (.998 compared to .962).
(3) Jim Locter can use the regression in his planning for temporary workers if the
following conditions exist:
(a) The forecasted daily shipments are greater than 300 and do not deviate
too much from the actual shipments.
(b) The amount of work to be done is dependent only on the number of
shipments to be made and does not change from shipment to shipment.
(c) Worker productivity is expected to remain approximately the same as
that experienced during the period used to develop the regression.
(d) A strong cause and effect relationship exists between the dependent
variable and the independent variable.
(e) The time frame for a forecast is short-term.
(4) The regression could be improved by the following:
(a) Redeveloping the regression using the number of hours worked as the
dependent variable.
(b) Performing another analysis if rush orders or deviations of actual orders
from forecasts occur with any degree of regularity.
(c) Investigating the historical data used as a basis for the regression to
determine if there are any further unusual circumstances that should be
removed from the data set.
(d) Redoing the regression after a period of time, such as four to six
months, to discover if there have been any changes in the relationship
between the dependent and the independent variables.
C3-2

(1) The increase in y associated with a unit increase in x is 1.2. Therefore, a 500-
unit increase in x will result in a 600-unit increase (1.2 × 500) in y (direct labor
hours).
(2) (a) The equation may be unreliable if the correlation is spurious. The
assumption is that there is a logical relationship between output and the
use of electric power and direct labor.
(b) The equation may be reliable under the conditions at the time of the
study, but if conditions change, the results may be unreliable.
(c) Data used were limited to a range of 500–2,000 units.
(d) It is assumed that a straight-line assumption is valid.
(e) The coefficient of correlation is a measure of the extent to which two
variables are related linearly. It is a relative measure of goodness of fit.
More of the variation in y is explained by the regression equation for
direct labor hours than for electric power, that is, the equation for direct
labor hours is a better fit than the equation for electric power.
(f) The standard error of the estimate is a measure of variation from the
regression line. If the observations are normally distributed about the
regression equation, the standard error can be interpreted in the same
way as the standard deviation. The standard error is greater in the case
of direct labor hours than in the case of electric power.

CGA-Canada (adapted). Reprint with permission.

C3-3

(1) An advantage of Alternative A is that using time as an independent variable is

a convenient way to take into consideration all possible factors that may be
influencing the dependent variable during each period of time. A disadvantage
of Alternative A is that there is no logical relationship between years and
rental expense.
An advantage of Alternative B is that this method is logical because as rev-
enues increase, the stores increase, and, thus, rental expense increases. A
dis- advantage of Alternative B is that an estimate of revenues is required.
An advantage of Alternative C is that the mathematical calculations are rel-
atively easy and the method is easy to understand. A disadvantage of
Alternative C is that the arithmetic average is an oversimplification that does
not recognize any relationship between variables.
C3-3 (Concluded)

(2) Motorco Corporation should select Alternative B because the relationship

between revenue and the rental expense is logical, the coefficient of
correlation is high, and the standard error of the estimate is low.
(3) A statistical technique is an appropriate method for estimating rental expense
before Motorco actually contacts Alpha Auto Parts. A statistical technique
attempts to measure the covariation between the variables that are presumed
to have a cause and effect relationship, and such a relationship appears to
exist in this situation. Of course, Motorco is assuming that any relationships
that exist in the historical data will continue in the future without change.
Management may want to adjust the variables for changes that it expects will
occur, and Motorco may wish to introduce other quantitative variables.

C3-4

(1) The phrase “regression provides a relational statement rather than a causal
statement” means that regression analysis is used to determine a relationship,
but not necessarily a cause-and-effect relationship. A specific value for a
regression coefficient does not imply that the independent variable(s) causes
a change in the dependent variable.
(2) The meaning of each of the symbols in the basic formula for a regression
equa- tion follows:
y′i = estimated value of the i th observation of the dependent variable.
a = the y-axis intercept or constant term (e.g., the fixed portion of a
semivariable expense).
b = the regression coefficient corresponding to the independent variable x
(e.g., the variable cost element associated with a one unit change in
activity x).
xi = the i th observation of the first independent variable.
c = the regression coefficient corresponding to the independent variable z
(e.g., the variable cost element associated with a one unit change in
activity z).
zi = the i th observation of the second independent variable.
ei = the error term associated with the i th observation.
(3) Statistical factors used to test a regression equation for goodness of fit include:
(a) The coefficient of determination, r 2, which indicates the portion of the
variance in the dependent variable explained by the independent
variables. A coefficient of determination approaching 1 indicates a
good fit.
C3-4 (Concluded)

(b) The standard error of the estimate which measures the dispersion of the
observed points about the regression line. A standard error of the
estimate approaching zero indicates a good fit.
(4) (a) The term “linearity within a relevant range” means that in a specific
situation, a straight-line relationship between the dependent variable and
the independent variables can be assumed only within the range of
historically observed values.
(b) The term “constant variance (homoscedasticlty)” means that the
distribution of the observations about the regression line is uniform for
all values of the independent variables within the observed range of
values.
(c) The term “serial correlation” refers to the lack of independence in a
series of successive observations over time. The deviation of a value
from the regression line should be unrelated to the deviation of any
other point from this line.
(d) The term “normality” means that the joint probability distribution of the
variables is normally distributed (multivariate normal). The frequency
of the observations should approximate a normal curve.
(e) The term “multicollinearity” refers to the correlation of independent
variables. When independent variables are highly correlated with each
other, the relationship(s) between the independent variables may
obscure the relationship between the independent variables(s) and the
dependent variable.

C3-5

(1) (a) D = (2.455 + (.188)(1,500,000 ÷ 100,000)) × 10,000 units

= (2.455 + 2.82) × 10,000 units
= 5.275 × 10,000 units
= 52,750 units
(b) D = (2.491 + (.44)(12,000,000 ÷ 1,000,000)) × 10,000 units
= (2.491 + 5.28) × 10,000 units
= 7.771 × 10,000 units
= 77,710 units
(2) The 50% confidence interval for demand is calculated as follows:
D = 104,160 units ± (.69)(.922 × 10,000 units)
= 104,160 units ± 6,361.8 units
or between 97,798 units and 110,522 units.
C3-5 (Concluded)

(3) Equation 4 is the best. The coefficient of correlation and the coefficient of
deter- mination are the highest of the four equations. The coefficient of
determination indicates that 70.3% of the sample variance of automobile sales
is explained by the regression. For predictive purposes, the standard error of
the estimate at
.922 is also the lowest of the four models, giving the tightest (smallest) physi-
cal confidence interval of any of the equations.
(4) Equation 3 assumes that factory rebates (R) are dependent on advertising
funds (A). The results of the analysis show that factory rebates and
advertising funds are almost totally independent and, therefore, cannot be
used to predict each other. The results of Equation 3 lend credibility to the use
of A and R in Equation 4. The independence of A and R reduces the possible
negative aspects of collinearity.