BX3172-Week two- Chapter three

Q 1,4, 6, 11, 14,

E 3-35, 3-45, 3-47, 3-59, 3-61, 3-62 (3&4), 3-64, 3-65 (1 &2 only)
1. Why is knowledge of cost behaviour important for managerial decision making? Give an example
to illustrate your answer.

4. Some firms assign mixed costs to either the fixed or variable cost categories without using any
formal methodology to separate them. Explain how this practice can be defended.

6. Explain why the concept of relevant range is important when dealing with step costs.

11. Briefly discuss how using data visualization (an aspect of data analytics) can help accountants and
other business decision makers better understand important cost behaviour patterns.

14. Describe the method of least squares. Why is this method better than either the high-low
method or the scatter graph method?

Exercise 3-35 Variable and Fixed Costs

Objective 1

What follows are a number of resources that are used by a manufacturer of futons. Assume that the
output measure or cost driver is the number of futons produced. All direct labor is paid on an hourly
basis, and hours worked can be easily changed by management. All other factory workers are
salaried.

a. Power to operate a drill (to drill holes in the wooden frames of the futons) Mixed
b. Cloth to cover the futon mattress
c. Salary of the factory receptionist Fixed
d. Cost of food and decorations for the annual Fourth of July party for all factory employees
e. Fuel for a forklift used to move materials in a factory Mixed
f. Depreciation on the factory Fixed
g. Depreciation on a forklift used to move partially completed goods Fixed
h. Wages paid to workers who assemble the futon frame Mixed
i. Wages paid to workers who maintain the factory equipment Mixed
j. Cloth rags used to wipe the excess stain off the wooden frames

Required:

Classify the resource costs as variable or fixed.

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Exercise 3-45 High-Low Method (Objective 3)

Sophia operates a full-service day spa in a small college town. Recently, Sophia rented space next to
her spa and opened a spray tanning salon. She anticipated that the costs for the spray tanning
service would primarily be fixed, but found that tanning salon costs increased with the number of
appointments. Costs for this service over the past 8 months are as follows:

Month Tanning Appointments Total Cost

January 1,500 $36,900
February 1,600 38,250
March 1,700 39,000
April 1,400 33,750
May 1,300 36,000
June 1,625 40,000
July 1,350 35,100
August 1,200 33,000

Required:

1. Which month represents the high point? The low point? High point = March 1,700 Low point =
August 1,200
2. Using the high-low method, compute the variable rate for tanning. Next, compute the fixed cost
per month.

Variable rate for tanning is $12 per unit.

Total variable cost = 12 x 17,00 = 20,400

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 Total Cost = 39, 000
Fixed Cost = 39,000 – 20,400 = 18,600

3. Using your answers to Requirement 2, write the cost formula for tanning services.
Cost formula = Y = 18,600 + 12X
*X Number of appointments
4. Calculate the total predicted cost of tanning services for September for 1,650 appointments
using the formula found in Requirement 3. Of that total cost, how much is the total fixed cost for
September? How much is the total predicted variable cost for September?
18,600 + 12X *(X: being the number of appointments)
=18,600 + (12 x 1650)
= 38,400
5. Calculate the total predicted cost of tanning services for September for 2,100 appointments
using the formula in Requirement 3. Briefly explain any concern that Sophia should have in using
this cost prediction.
18,600 + (12 x 2100)
= 43,800
6. CONCEPTUAL CONNECTION Identify and briefly explain any additional issue(s) that
Sophia might be wise to consider when using the high-low method to estimate the costs of her
tanning salon.

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Exercise 3-47 Method of Least Squares (Objective 3)

Sophia operates a full-service day spa in a small college town. Recently, Sophia rented space next to
her spa and opened a spray tanning salon. She anticipated that the costs for the spray tanning
service would primarily be fixed but found that tanning salon costs increased with the number of
appointments. Costs for this service over the past 8 months are as follows:

Month Tanning Appointments Total Cost

January 1,500 $36,900
February 1,600 38,250
March 1,700 39,000
April 1,400 33,750
May 1,300 36,000
June 1,625 40,000
July 1,350 35,100
August 1,200 33,000

Required:

1. Using a computer spreadsheet program such as Excel, run a regression on these data. Based on
the regression output, write the cost formula for tanning. (Note: Round the fixed cost to the
nearest dollar and the variable rate to the nearest cent.)
Cost Formula: Y = 18,600 + 12X *Where X = Number of appointments
2. Using the formula computed in Requirement 1, what is the predicted cost of tanning services for
September for 1,550 appointments?
18,600+(12x1550)
=18,600+18,600
=37,200 <*(CHECK THE OFFICAL SOLUTIONS TO SEE IF THIS ANSWER IS CORRECT OR NOT).
Problem 3-59 Identifying Fixed, Variable, Mixed, and Step Costs (Objective 1 2)

Consider each of the following independent situations:

A computer service agreement in which a company pays $150 per month and $15 per hour of
technical time
a. Fuel cost of the company’s fleet of motor vehicles
b. The cost of beer for a bar
c. The cost of computer printers and copiers at your college
d. Rent for a dental office
e. The salary of a receptionist in a law firm
f. The wages of counter help in a fast-food restaurant
g. The salaries of dental hygienists in a three-dentist office. One hygienist can take care of 120
cleanings per month.

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h. Electricity cost which includes a $15 per month billing charge and an additional amount
depending on the number of kilowatt-hours used

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Required:

1. For each situation, describe the cost as one of the following: fixed cost, variable cost, mixed cost,
or step cost. (Hint: First, consider what the driver or output measure is. If additional assumptions
are necessary to support your cost type decision, be sure to write them down.)
2. Example: Raw materials used in production—Variable cost
3. CONCEPTUAL CONNECTION Change your assumption(s) for each situation so that the cost type
changes to a different cost type. List the new cost type and the changed assumption(s) that gave
rise to it.
4. Example: Raw materials used in production. Changed assumption—the materials are difficult to
obtain, and a year’s worth must be contracted for in advance. Now, this is a fixed cost.

Problem 3-61 Identifying Variable Costs, Committed Fixed Costs, and Discretionary Fixed Costs

Objective 1

Required:

Classify each of the following costs for a jeans manufacturing company as a variable cost, committed
fixed cost, or discretionary fixed cost.

a. The cost of buttons

b. The cost to lease warehouse space for completed jeans—the lease contract runs for 2 years
at $5,000 per year
c. The salary of a summer intern
d. The cost of landscaping and mowing the grass—the contract with a local mowing company
runs from month to month
e. Advertising in a national magazine for teenage girls
f. Electricity to run the sewing machines
g. Oil and spare needles for the sewing machines
h. Quality training for employees—typically given for 4 hours at a time, every 6 months
i. Food and beverages for the company Fourth of July picnic
j. Natural gas to heat the factory during the winter

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Problem 3-62 Scattergraph, High-Low Method, and Predicting Cost for a Different Time Period

Objective 3
Shafer Company has gathered data on its overhead activities and associated costs for the past 10
months. Theodore, a member of the controller’s department, has convinced management that
overhead costs can be better estimated and controlled if the fixed and variable components of each
overhead activity are known. One such activity is receiving raw materials (unloading incoming goods,
counting goods, and inspecting goods), which she believes is driven by the number of receiving
orders. Ten months of data have been gathered for the receiving activity and are as follows:

Refer to the information for Shafer Company above.

Required:
1. Examine the table of Shafer’s monthly data given in the problem. Based on your examination of
this table, does the relationship appear to be linear?
2. Prepare a scattergraph based on the 10 months of data. Based on your examination of this
scattergraph, does the relationship appear to be linear? Briefly comment on whether it was
easier to assess the linearity of the relationship by examining the table or the scattergraph plot.

3. Using the high-low method, prepare a cost formula for the receiving activity. Using this formula,
what is the predicted cost of receiving for a month in which 1,450 receiving orders are
processed?
4. Prepare a cost formula for the receiving activity for a quarter. Based on this formula, what is the
predicted cost of receiving for a quarter in which 4,650 receiving orders are anticipated? Prepare
a cost formula for the receiving activity for a year. Based on this formula, what is the predicted
cost of receiving for a year in which 18,000 receiving orders are anticipated?
5. Once again examine the table of Shafer’s monthly data and assess whether any month appears
to be an outlier. Now examine your scattergraph plot and again assess whether any month
appears to be an outlier. Briefly explain how visualizing Shafer’s data in the scattergraph plot
affects your ability to detect possible outliers.

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Problem 3-64 Method of Least Squares, Predicting Cost for Different Time Periods from the One
Used to Develop a Cost Formula (Objective 3)

Refer to the information for Shafer Company above. However, assume that Theodore has used the
method of least squares on the receiving data and has obtained the following results:

Intercept 3,212
Slope 15.15

Required:
1. Using the results from the method of least squares, prepare a cost formula for the receiving
activity.

Intercept 3,212 <Fixed cost

Slope 15.15 <Variable Cost per Unit

Cost formula = 3,212 + 15.15 x X X = Number of receiving activity

2. Using the formula from Requirement 1, what is the predicted cost of receiving for a month in
which 1,450 receiving orders are processed? (Note: Round your answer to the nearest dollar.)

= 3212 + (15.15*1450)
= 25179.5
= $ 21,180 (rounded to the nearest dollar)

3. Prepare a cost formula for the receiving activity for a quarter. Based on this formula, what is the
predicted cost of receiving for a quarter in which 4,650 receiving orders are anticipated?

Part 3 Total Fixed Cost 9636 (3x 3212)

Total Variable Cost 70447.5 (15.15 x 4650)
Total Cost 80083.5 (round off from 80.084)(9636 + 70447.5)

4. Prepare a cost formula for the receiving activity for a year. Based on this formula, what is the
predicted cost of receiving for a year in which 18,000 receiving orders are anticipated? Round
variable cost per unit to two decimal places and total fixed cost to the nearest dollar.

Part 4 Total Fixed Cost 38544 (3212 x 12)

Total Variable Cost 272700
Total Cost 311244 (38544 + 272700)

*Careful with fixed cost, for part 3 you need to multiple with 3 ( total fixed cost for quarter)
Part 4 Fixed cost per month x 12 (ttoal fixed cost for the year)

Problem 3-65 Cost Behaviour, High-Low Method, Pricing Decision (Objective 1 2 3)

Fonseca, Ruiz, and Dunn is a large, local accounting firm located in a southwestern city. Carlos Ruiz,
one of the firm’s founders, appreciates the success his firm has enjoyed and wants to give something
back to his community. He believes that an inexpensive accounting services clinic could provide basic
accounting services for small businesses located in the barrio. He wants to price the services at cost.

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Since the clinic is brand new, it has no experience to go on. Carlos decided to operate the clinic for 2
months before determining how much to charge per hour on an ongoing basis. As a temporary
measure, the clinic adopted an hourly charge of $25, half the amount charged by Fonseca, Ruiz, and
Dunn for professional services.

The accounting services clinic opened on January 1. During January, the clinic had 120 hours of
professional service. During February, the activity was 150 hours. Costs for these two levels of
activity usage are as follows:

120 Professional Hours 150 Professional Hours

Salaries:
Senior accountant $2,500 $2,500
Office assistant 1,200 1,200
Internet and software subscriptions 700 850
Consulting by senior partner 1,200 1,500
Depreciation (equipment) 2,400 2,400
Supplies 905 1,100
Administration 500 500
Rent (offices) 2,000 2,000
Utilities 332 365
Required:

1. Classify each cost as fixed, variable, or mixed, using hours of professional service as the
activity driver.
Classification Logic/Rationale

Salary accountant Fixed Remain same or constant irrespective of number of hours worked
Office assitant Fixed
internet Mixed
Consulting by senior partner Variable Cost $10 per hour remains constant (1200/120 =$10 and (1500/150 = $10)
Depreciation (equipment) Fixed
Supplies Mixed
Administration Fixed
Rent Fixed
Utilities Mixed

2. Use the high-low method to separate the mixed costs into their fixed and variable
components. (Note: Round variable rates to two decimal places and fixed amounts to the
nearest dollar.)

3. Luz Mondragon, the chief paraprofessional of the clinic, has estimated that the clinic will
average 140 professional hours per month. If the clinic is to be operated as a nonprofit
organization, how much will it need to charge per professional hour? How much of this
charge is variable? How much is fixed? (Note: Round answers to two decimal places.)

4. CONCEPTUAL CONNECTION Suppose the accounting center averages 170 professional

hours per month. How much would need to be charged per hour for the center to cover its
costs? Explain why the per-hour charge decreased as the activity output increased. (Note:
Round answers to two decimal places.)

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Management Accounting Week 2

Y = Theta + Beta X

Total Cost = Fixed Cost + Variable Cost per unit

Regression Equation for Total Cost = y (dependent variable) = alpha (fixed cost) + beta (variable cost
per unit) x X (quantity or output or cost driver)

Lecturer’s tip: *Cost Behaviours: Managers need to anticipate future costs, and to understand that
they need to understand cost drivers. Fixed cost usually can’t be changed because they are essential
(like rent), but variable costs can be saved for more efficiency. That is why understanding fixed and
variable cost is important, and to understand that we need to understand an organization’s
operations and environment. Fixed costs usually can’t be avoided, even when there is no business.

Learn to do regression analysis in Excel.

*For test and exam – study high-low method, two – point method, regression analysis

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