Chapter 6, Problem 44P

The controller of Chittenango Chain Company believes that the identification of the variable and fixed components of the firm’s costs will enable the firm to make better planning and control decisions. Among the costs the controller is concerned about is the behavior of indirect-materials cost. She believes there is a correlation between machine hours and the amount of indirect materials used.

A member of the controller’s staff has suggested that least-squares regression be used to determine the cost behavior of indirect materials. The regression equation shown below was developed from 40 pairs of observations.

$\begin{array}{l}\text{S}=\$200+\$4\text{H}\\ \text{where}\text{S}=\text{Total}\text{monthly}\text{cost}\text{of}\text{indirect}\text{materials}\\ \text{H}=\text{Machine}\text{hours}\text{per}\text{month}\end{array}$

Required:

1. 1. Explain the meaning of “200” and “4” in the regression equation S = $200 + $4H.
2. 2. Calculate the estimated cost of indirect materials if 900 machine hours are to be used during a month.
3. 3. To determine the validity of the cost estimate computed in requirement (2), what question would you ask the controller about the data used for the regression?
4. 4. The high and low activity levels during the past four years, as measured by machine hours, occurred during April and August, respectively. Data concerning machine hours and indirect-material usage follow.

Determine the cost of indirect materials used during April and August.

1. 5. Use the high-low method to estimate the behavior of the company’s indirect-material cost. Express the cost behavior pattern in equation form.
2. 6. Which cost estimate would you recommend to the controller, the regression estimate or the high-low estimate? Why?