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Discussion Questions
Discussion Questions
DISCUSSION QUESTIONS
Q3-1. The total dollar amount of a fixed cost is con- costs is expediency, i.e., it requires less time
stant at different levels of activity within the and is, therefore, less costly than the use of
relevant range, but fixed cost per unit of activ- any of the three computational methods. The
ity varies. In contrast, the total amount of a disadvantage is that the use of managerial
variable cost varies at different levels of activ- judgment to separate fixed and variable costs
ity, but the variable cost per unit remains con- often results in unreliable estimates of cost.
stant within the relevant range. A semivariable Cost behavior is not always readily apparent
cost contains both fixed and variable ele- from casual observation. As a consequence,
ments. Consequently, both total semivariable managers often err in determining whether a
cost and semivariable cost per unit vary with cost is fixed or variable and frequently ignore
changes in activity. the possibility that some costs are semivari-
Q3-2. The relevant range is the range of activity able.
over which a fixed cost remains constant in Q3-5. The three computational methods available
total or a variable cost remains constant per for separating the fixed and variable compo-
unit of activity. The underlying assumptions nents of semivariable costs are: (1) the high
about the relationship of the activity and the and low points method; (2) the statistical scat-
incurrence of cost change outside the rele- tergraph method; and (3) the method of least
vant range of activity. Consequently, the squares.
amount of fixed cost or the variable cost rate Q3-6. The high and low points method has the
must be recomputed for activity above or advantage of being simple to compute, but it
below the relevant range. has the disadvantage of using only two data
Q3-3. The fixed and variable components of a semi- points in the computation, thereby resulting in
variable cost should be segregated in order to a significant potential for bias and inaccuracy
plan, analyze, control, measure, and evaluate in cost estimates. The scattergraph has the
costs at different levels of activity. Separation advantage of using all of the available data,
of the fixed and variable components of semi- but it has the disadvantage of determining the
variable cost is necessary to: fixed and variable components on the basis of
(a) compute predetermined factory overhead a line drawn by visual inspection through a
rates and analyze variances; plot of the data, thereby resulting in bias and
(b) prepare flexible budgets and analyze vari- inaccuracy in cost estimates. The method of
ances; least squares has the advantage of accu-
(c) analyze direct cost and the contribution rately describing a line through all the avail-
margin; able data, thereby resulting in unbiased
(d) determine the break-even point and ana- estimates of the fixed and variable elements
lyze the effect of volume on cost and of cost, but it has the increased disadvantage
profit; of computational complexity.
(e) compute differential cost and make com- Q3-7. The $200 in the equation, referred to as the
parative cost analyses; y intercept, is an estimate of the fixed portion
(f) maximize short-run profits and minimize of indirect supplies cost. The $4 in the equa-
short-run costs; tion, referred to as the slope of the regres-
(g) budget capital expenditures; sion equation, is an estimate of the variable
(h) analyze marketing profitability by territo- cost associated with a unit change in
ries, products, and customers. machine hours. These estimates may not be
Q3-4. The obvious advantage to using managerial perfectly accurate because they were derived
judgement to separate fixed and variable from a sample of data that may not be entirely
3-1
3-2 Chapter 3
representative of the universe population, good fit. A standard error of zero would indi-
and because activities not included in the cate a perfect fit, i.e., all actual observations
regression equation may have some influ- would be on the regression fine.
ence on the cost being predicted. Q3-10. Heteroscedasticity means that the distribution
Q3-8. The coefficient of correlation, denoted r, is a of observations around the regression line is
measure of the extent to which two variables not uniform for all values of the independent
are related linearly. It is a measure of the variable. If heteroscedasticity is present, the
covariation of the dependent and independ- standard error of the estimate and confidence
ent variables, and its sign indicates whether interval estimates, based on the standard
the independent variable has a positive or error, are unreliable measures.
negative relationship to the dependent vari- Q3-11. Serial correlation means that rather than
able. The coefficient of determination is the being random, the observations around the
square of the coefficient of correlation and is regression line are correlated with one
denoted r 2. The coefficient of determination is another. If serial correlation is present, the
a more easily interpreted measure of the standard error of the estimate and confidence
covariation than is the coefficient of correla- interval estimates, based on the standard
tion, because it represents the percentage of error, are unreliable measures.
variation in the dependent variable explained Q3-12. Multicollinearity means that two or more of
by the independent variable. the independent variables in a multiple
Q3-9. The standard error of the estimate is defined regression analysis are correlated with one
as the standard deviation about the regres- another. When the degree of multicollinearity
sion line. It is essentially a measure of the is high, the relationship between one or more
variability of the actual observations of the of the correlated independent variables and
dependent variable from the points predicted the dependent variable may be obscured.
on the regression line. A small value for the However, this circumstance would normally
standard error of the estimate indicates a not affect the estimate of cost.
Chapter 3 3-3
EXERCISES
E3-1
Activity Level Cost
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
E3-3
Σ( x i − x )(y i − y ) 87, 000
b= = = $60
Σ( x i − 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
E3-5
Σ( x i − x )(y i − y ) 1, 564
r= = = .92
Σ( x i − x )2 Σ(y i − y )2 (850) (3, 400)
r 2 = (.92)2 − .8464
E3-6
E3-7
E3-8
(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).
Chapter 3 3-7
E3-8 (Concluded)
E3-9
E3-10
Σ(y i − y ′i )2 $49, 972
s′= = = 3, 844 = $62
n −2 15 − 2
1 ( x i − x )2
y ′i ± t 90% s′ 1+ +
n Σ( x i − x )2
1 (1, 500 − 1, 300)2
$500 ± (1.771)($62) 1+ +
15 150, 000
$500 ± (1.771)($62) 1.3333
$500 ± (1.771)($62) (1
1.1547 )
$500 ± $126.79
Chapter 3 3-9
PROBLEMS
P3-1
P3-1 (Concluded)
P3-2
(1)
r 2 = (.977 )2 = .955
3-12 Chapter 3
P3-2 (Concluded)
(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:
P3-3
r 2 = (.826)2 = .682
3-14 Chapter 3
P3-3 (Concluded)
r 2 = (.933)2 = .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 − x )2 Column 5 total 211, 200
Fixed cost (a ) = y − bx
= $1, 580 − ($.32339)(2, 300)
= $836.20
Chapter 3 3-15
P3-4
(1)
Maintenance Machine
Cost Hours
High ................................................................. $2,290 2,700
Low .................................................................. 2,000 2,000
Difference........................................................ $ 290 700
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
P3-4 (Concluded)
(3)
Σ( x − x )(y − y ) Column 6 total
r= =
Σ( x i − x )2 Σ(y i − y )2 olumn 7 total)
(Column 5 total) (Co
172, 000 172, 000 172, 000
r= = = = .9565
(430, 000)(75, 200) 000 179, 822
32, 336, 000,0
r 2 = (.9565)2 = .91489
(4) (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)
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
(5) The 95% confidence interval for maintenance cost at the 2,500 machine hour
level of activity is
1 ( x i − x )2
y ′ ± t 95% s′ 1+ +
n Σ( 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
Chapter 3 3-17
P3-5
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 = = $.1091 per 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
$900
Dec. Sept. Aug.
$800
Apr. & Oct. June
$700
$600
May & Nov.
$500
Feb. Mar.
$400
Jan.
Approx. $350
$300
$200
$100
$0
0 1,000 2,000 3,000 4,000 5,000 6,000 7,000
P3-5 (Continued)
(2) The coefficient of correlation (r) and the coefficient of determination (r2), using
data from the requirement (1)(a) answer:
Σ( x i − x )(y i − y ) Column 6 total
r = =
Σ( x i − x )2 Σ(y i − y )2 (Column 5 total) (Column 7 total)
3, 450, 000 3, 450, 000
r = =
(34, 000, 000)(380, 000) 12, 920, 000, 000, 000
3, 450, 000
= = .9598
3, 594, 440
r 2 = .9212
P3-5 (Concluded)
(4) The 90% confidence interval for electricity cost at 2,000 guest days would be:
1 ( x i − x )2
y ′i ± t 90% s′ 1+ +
n Σ( x i − x )2
1 (2, 000 − 3, 500)2
($345 + ($.1015)(2, 000)) ± (1.812)($54.75) 1+ +
12 34, 000, 000
$548± (1.812)($54.75)(1.072)
$548 ± $106.35
P3-6
Cost Activity
High ................................................................ $500 2,400
Low ................................................................. 400 1,400
Difference ....................................................... $100 1,000
Variable rate = $100 ÷ 1,000 Billets = $.10
P3-6 (Continued)
$500
$400
$300
ELECTRICITY
$200
$100
$0
0 500 1,000 1,500 2,000 2,500
BILLETS
P3-6 (Continued)
(c)
(2) The coefficient of correlation (r) and the coefficient of determination (r2), using
data from the answer in requirement (1)(c) follow:
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
1 ( x − x )2
a + bx ± t 95% s′ 1+ +
n Σ( x − x ) 2
1 (2,200 − 2,000)2
$257.50 + ($.10125)(2,200) ± (2.22
28)($8.672) 1+ +
12 800,000
$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.
3-24 Chapter 3
P3-7
(1)
(1) (2) (3) (4) (5) (6) (7)
yi (yi – y–) xi (xi – x–) (xi – x–)2 –) (y – y–)2
(xi – x–)(yi – y i
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
Chapter 3 3-25
P3-7 (Continued)
(2) The coefficient of correlation and the coefficient of determination, using data
from the requirement (1) answer:
r 2 = (.9370)2 = .8780
3-26 Chapter 3
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
Chapter 3 3-27
P3-7 (Concluded)
(4) Since a large sample is used in this problem, t95% = z95% and the confidence
interval is:
y ′i ± z 95% s′
($3, 940 + ($2.20)(2, 200)) ± (1.960)($324 )
$8, 780 ± $635
3-28 Chapter 3
P3-8
(1)
P3-8 (Continued)
P3-8 (Continued)
(2) The activity measure used to predict maintenance expense should be machine
hours, which will result in the following cost estimates:
P3-8 (Concluded)
(4) The 95% confidence interval for maintenance cost at the 1,100 machine hour
level of activity is:
1 ( x i − x )2
y ′i ± t 95% s′ 1+ +
n Σ( x i − 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
3-32 Chapter 3
CASES
C3-1
(1) W = a + bS
= 5.062 + (.023) (1,200)
= 5.062 + 27.6
= 32.662 or about 33 total workers
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.
C3-3
C3-3 (Concluded)
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.
Chapter 3 3-35
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
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.