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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.

S = $200 + $9H

where S = Total monthly cost of indirect materials

          H = Machine hours per month

3. To determine the validity of the cost estimate computed in requirement (2), what question(s) would you ask the controller about the data used for the regression? (You may select more than one answer. Single click the box with the question mark to produce a check mark for a correct answer and double click the box with the question mark to empty the box for a wrong answer.)

• Do the observations contain any outliers, or are they all representative of normal operations?
• Are there any mismatched time periods in the data? Are all of the indirect material cost observations matched properly with the machine hour observations?
• Are there any allocated costs included in the indirect material cost data?
• Are the cost data affected by inflation?
• None of the above.

Answer 1

As the cost is estimated as per least square regression (Mathematical formula) method. We have to ask some question to determine the validity of cost estimated.

1.) Do the observations contain any outliers, or are they all representative of normal operations?

Because if it contains any outliers. then formula would give you the wrong estimation.

2.) Are there any mismatched time periods in the data? Are all of the indirect material cost observations matched properly with the machine hour observations?