Chapter 6, Problem 50C

Earth and Artistry, Inc. provides commercial landscaping services. Sasha Cairns, the firm’s owner, wants to develop cost estimates that she can use to prepare bids on jobs. After analyzing the firm’s costs, Cairns has developed the following preliminary cost estimates for each 1,000 square feet of landscaping.

Cairns is quite certain about the estimates for direct material and direct labor. However, she is not as comfortable with the overhead estimate. The estimate for overhead is based on the overhead costs that were incurred during the past 12 months as presented in the following schedule. The estimate of $18 per direct-labor hour was determined by dividing the total overhead costs for the 12-month period ($648,000) by the total direct-labor hours (36,000).

Cairns believes that overhead is affected by total monthly direct-labor hours. Cairns decided to perform a least-squares regression of overhead (OH) on total direct-labor hours (DLH). The following regression formula was obtained.

   $OH=26,200+9.25DLH$

Required:

1. 1. The overhead rate developed from the least-squares regression is different from Cairns’ preliminary estimate of $18 per direct-labor hour. Explain the difference in the two overhead rates.
2. 2. Using the overhead formula that was derived from the least-squares regression, determine a total variable-cost estimate for each 1,000 square feet of landscaping.
3. 3. Cairns has been asked to submit a bid on a landscaping project for the city government consisting of 60,000 square feet. Cairns estimates that 40 percent of the direct-labor hours required for the project will be on overtime. Calculate the incremental costs that should be included in any bid that Cairns would submit on this project. Use the overhead formula derived from the least-squares regression.
4. 4. Should management rely on the overhead formula derived from the least-squares regression as the basis for the variable overhead component of its cost estimate? Explain your answer.
5. 5. After attending a seminar on activity-based costing, Cairns decided to further analyze the company’s activities and costs. She discovered that a more accurate portrayal of the firm’s cost behavior could be achieved by dividing overhead into three separate pools, each with its own cost driver. Separate regression equations were estimated for each of the cost pools, with the following results.

OH₁ = 10,000 + 4.10DLH,

where DLH denotes direct-labor hours

OH₂ = 9,100 + 13.50SFS,

where SFS denotes the number of square feet of turf seeded (in thousands)

OH₃ = 8,000 + 6.60PL,

where PL denotes the number of individual plantings (e.g., trees and shrubs)

Assume that 5 direct-labor hours will be needed to landscape each 1,000 square feet, regardless of the specific planting material used.

1. a.      Suppose the landscaping project for the city will involve seeding all 60,000 square feet of turf and planting 80 trees and shrubs. Calculate the incremental variable overhead cost that Cairns should include in the bid.
2. b.      Recompute the incremental variable overhead cost for the city’s landscaping project assuming half of the 60,000-square-foot landscaping area will be seeded and there will be 250 individual plantings. The plantings will cover the entire 60,000-square-foot area.
3. c.       Briefly explain, using concepts from activity-based costing, why the incremental costs differ in requirements (a) and (b).