ACC 220 Lecture Notes - Lecture 6: Fixed Cost, Ordinary Least Squares, Total Absorption Costing

EXERCISE 2-11 High-Low Method; Scattergraph Analysis [LO2-4, LO2-5] The following data relating to units shipped and total shipping expense have been assembled by Archer Company, a wholesaler of large, custom-built air-conditioning units for commercial buildings: Month Units Shipped Total Shipping Expense January ... February March April May ...... June ....... July ........ Novo A6 $1,800 $2,300 $1,700 $2,000 $2,300 $2,700 $1,200 Required: 1. Prepare a scattergraph using the data given above. Plot cost on the vertical axis and activity on the horizontal axis. Is there an approximately linear relationship between shipping expense and the number of units shipped? 2. Using the high-low method, estimate the cost formula for shipping expense. Draw a straight line through the high and low data points shown in the scattergraph that you prepared in requirement 1. Make sure your line intersects the Y axis. 3. Comment on the accuracy of your high-low estimates assuming a least-squares regression analysis estimated the total fixed costs to be $910.71 per month and the variable cost to be $217.86 per unit. How would the straight line that you drew in requirement 2 differ from a straight line that minimizes the sum of the squared errors? What factors, other than the number of units shipped, are likely to affect the company's ship- ping expense? Explain. 4.

EXERCISE 2-14 High-Low Method; Predicting Cost [L02-4, LO2-5] The Lakeshore Hotel's guest-days of occupancy and custodial supplies expense over the last seven months were: Guest-Days of Occupancy Custodial Supplies Expense Month March ....... April May June ...... July ........ August September ...... 4,000 6,500 8,000 10,500 12,000 9,000 7,500 $7,500 $8,250 $10,500 $12,000 $13,500 $10,750 $9,750 . . . . . . Guest-days is a measure of the overall activity at the hotel. For example, a guest who stays at the hotel for three days is counted as three guest-days. Required: 1. Using the high-low method, estimate a cost formula for custodial supplies expense. 2. Using the cost formula you derived above, what amount of custodial supplies expense would you expect to be incurred at an occupancy level of 11,000 guest-days? 3. Prepare a scattergraph using the data given above. Plot custodial supplies expense on the ver- tical axis and the number of guest-days occupied on the horizontal axis. Draw a straight line 4. through the two data points that correspond to the high and low levels of activity. Make sure your line intersects the Y-axis. Comment on the accuracy of your high-low estimates assuming a least-squares regression analysis estimated the total fixed costs to be $3,973.10 per month and the variable cost to be $0.77 per guest-day. How would the straight line that you drew in requirement 3 differ from a straight line that minimizes the sum of the squared errors? Using the least-squares regression estimates given in requirement 4, what custodial supplies expense would you expect to be incurred at an occupancy level of 11,000 guest-days? 5. Net operating income. $ 6,000 $ 18,000 $ 30,000 Required: 1. Identify each of the company's expenses (including cost of goods sold) as either variable, fixed, or mixed. 2. Using the high-low method, separate each mixed expense into variable and fixed elements. State the cost formula for each mixed expense. 3. Redo the company's income statement at the 5,000-unit level of activity using the contribution format.

PROBLEM 2-22 High-Low and Scattergraph Analysis (L02-4, LO2-5) Pleasant View Hospital of British Columbia has just hired a new chief administrator who is anx- ious to employ sound management and planning techniques in the business affairs of the hospital. Accordingly, she has directed her assistant to summarize the cost structure of the various depart- ments so that data will be available for planning purposes. The assistant is unsure how to classify the utilities costs in the Radiology Department because these costs do not exhibit either strictly variable or fixed cost behavior. Utilities costs are very high in the department due to a CAT scanner that draws a large amount of power and is kept running at all times. The scanner can't be turned off due to the long warm-up period required for its use. When the scanner is used to scan a patient, it consumes an additional burst of power. The assistant has accumulated the following data on utilities costs and use of the scanner since the first of the year. Month Number of Scans Utilities Cost [ 60 January February .... March April May ....... June July ........- August September October $2,200 $2,600 $2,900 $3,300 $3,000 $3,600 $4,000 $3,600 $3,100 $2,500 130 150 140 The chief administrator has informed her assistant that the utilities cost is probably a mixed cost that will have to be broken down into its variable and fixed cost elements by use of a scatter- graph. The assistant feels, however, that if an analysis of this type is necessary, then the high-low method should be used, since it is easier and quicker. The controller has suggested that there may be a better approach. Required: 1. Using the high-low method, estimate a cost formula for utilities. Express the formula in the form Y = a + bx. (The variable rate should be stated in terms of cost per scan.) 2. Prepare a scattergraph by plotting the number of scans and utility cost on a graph. Draw a straight line though the two data points that correspond to the high and low levels of activity. Make sure your line intersects the Y-axis. Comment on the accuracy of your high-low estimates assuming a least-squares regression analysis estimated the total fixed costs to be $1,170.90 per month and the variable cost to be $18.18 per scan. How would the straight line that you drew in requirement 2 differ from a straight line that minimizes the sum of the squared errors?