SCATTERGRAPH, HIGH-LOW METHOD, AND PREDICTING COST FOR A DIFFERENT TIME PERIOD FROM THE ONE USED TO DEVELOP A COST FORMULA
Farnsworth Company has gathered data on its overhead activities and associated costs for the past 10 months. Tracy Heppler, 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:
|
Month
|
Receiving Orders
|
Receiving Cost ($)
|
|
1
|
1,000
|
18,000
|
|
2
|
700
|
15,000
|
|
3
|
1,500
|
28,000
|
|
4
|
1,200
|
17,000
|
|
5
|
1,300
|
25,000
|
|
6
|
1,100
|
21,000
|
|
7
|
1,600
|
29,000
|
|
8
|
1,400
|
24,000
|
|
9
|
1,700
|
27,000
|
|
10
|
900
|
16,000
|
METHOD OF LEAST SQUARES
Refer to the above Farnsworth Company information for the first 10 months of data on receiving orders and receiving cost. Now suppose that Tracy has gathered two more months of data:
|
Month
|
Receiving Orders
|
Receiving Cost
|
|
11
|
1,200
|
$28,000
|
|
12
|
950
|
$17,500
|
For the following requirements, round the intercept terms to the nearest dollar and round the variable rates to the nearest cent.
Required:
1. Run two regressions using a computer spreadsheet program such as Excel. First, use the method of least squares on the first 10 months of data. Then, use the method of least squares on all 12 months of data. Write down the results for the intercept, slope, and R2 for each regression. Compare the results.
2. Prepare a scattergraph using all 12 months of data. Do any points appear to be outliers? Suppose Tracy has learned that the factory suffered severe storm damage during month 11 that required extensive repairs to the receiving area-including major repairs on a forklift. These expenses, included in month 11 receiving costs, are not expected to recur. What step might Tracy, using her judgment, take to amend the results from the method of least squares?
3. Rerun the method of least squares, using all the data except for month 11. (You should now have 11 months of data.) Prepare a cost formula for receiving based on these results, and calculate the predicted receiving cost for a month with 1,450 receiving orders. Discuss the results from this regression versus those from the regression for 12 months of data.