The Ramon Company manufactures a wide range of products at several different plant locations. The Franklin plant, which manufactures electrical components, has been experiencing some difficulties with fluctuating monthly overhead costs. The fluctuations have made it difficult to estimate the level of overhead that will be incurred for any one month. Management wants to be better able to estimate overhead costs accurately in order to plan its operations and financial needs. A trade association publication to which Ramon Company subscribes indicates that for companies that manufacture electrical components, overhead tends to vary with direct labor hours. One member of the accounting staff proposes that the cost behavior pattern for overhead costs be determined. Then, overhead costs could be predicted from the budgeted direct labor hours. Another member of the accounting staff suggests that a good starting point for determining the cost behavior patterns of overhead costs would be an analysis of historical data. The historical cost behavior pattern would provide a basis for determining the cost behavior pattern. The methods proposed for this purpose are the high-low method and simple linear regression. Data on direct labor hours and the respective overhead costs incurred were collected for the past two years. The raw data follow:
|
19a
|
Direct Labor Hours x
|
Overhead Costs y
|
|
January
|
20,000 hours
|
$84,000
|
|
February
|
25,000
|
99,000
|
|
March
|
22,000
|
89,000
|
|
April
|
23,000
|
90,000
|
|
May
June
July
August
September
October
November
December
|
20,000
19,000
14,000
10,000
12,000
17,000
16,000
19,000
|
81,000
75,000
70,000
64,000
69,000
75,000
71,000
78,000
|
|
19b
|
Direct Labor Hours x
|
Overhead Costs y
|
|
January
|
21,000 hours
|
$86,000
|
|
February
|
24,000
|
93,000
|
|
March
|
23,000
|
87,000
|
|
April
|
22,000
|
80,000
|
|
May
June
July
August
September
October
November
December
|
20,000
18,000
12,000
13,000
15,000
17,000
15,000
18,000
|
76,000
67,000
71,000
73,000
72,000
71,000
75,000
78,000
|
Using linear regression, the following data were obtained:
Coefficient of determination (r2) 0.9109
Coefficient of regression equation
Constant 39,859
Independent variable 2.1549
Standard error of the estimate (s,) 2,840
Standard error of the regression coefficient for the independent variable (sb) 0.1437
Table t-statistic for a 95% confidence interval (when n -2 = 24 -2 = 22) 2.074
(a) Using the high-low method, determine the cost behavior pattern of the overhead costs for the Franklin plant.
(b) Using the results of the regression analysis, calculate the estimate of overhead costs for 22,500 direct labor hours.
(c)Of the two proposed methods, which one should Ramon Company employ to determine the historical cost behavior pattern of the Frankliin plant's overhead costs? Explain your answer completely, indicating the reasons why the other method should not be used.
(CMA, adapted)
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