Question

Modelling Cost Behaviour

MEW has been contracted by one of its customers to produce two new components in the next year. The management accountant has been asked to prepare costings for the two new components and is concerned that the current method of calculating the overhead cost per unit is not accurate enough. She has collected monthly information for the current year on the fixed and variable overheads incurred and on potential alternative allocation bases that can be used to calculate the total overhead cost per unit.

Month	Volume	Machine Hours	Direct Labour (Machinists and Assembly only) Hours	Variable Overhead Costs	Fixed Overhead Costs
1	1,200	810	3,500	$ 7,700	$ 18,000
2	1,200	830	3,700	$ 8,700	$ 17,500
3	1,400	920	4,000	$ 9,500	$ 18,300
4	1,300	935	3,800	$ 9,000	$ 18,000
5	1,350	910	4,100	$ 9,800	$ 18,500
6	1,300	860	3,900	$ 9,000	$ 18,100
7	1,400	920	4,050	$ 9,600	$ 19,000
8	1,500	950	4,400	$ 9,700	$ 19,000
9	1,250	820	3,500	$ 8,300	$ 17,900
10	1,400	880	4,033	$ 9,100	$ 19,000
11	1,300	887	3,800	$ 8,600	$ 18,200
12	1,400	945	4,150	$ 9,800	$ 18,500
Total	16,000	10,667	46,933	$ 108,800	$ 220,000

Required:

1. (a) Use the data provided to identify which of the three potential cost drivers (or combination of cost drivers) should be used to estimate the total overhead cost per unit. Prepare a regression analysis using the cost driver(s) you have selected (you may want to look at scatterplots and prepare alternative regression equations to make your decision).

2. (b) Prepare a memo for the CFO that explains (i) why it is necessary to use a more accurate method of allocating overheads for determining the total cost of the new components and (ii) explains how you decided which cost drivers to include in your regression. You should add supporting evidence and/or calculations to show how you came to your conclusion. Also, write out your annual total overhead cost equation using your regression results. Note the CFO requests a memo of no more than one page (within specified margins and font size) excluding any regression results or supporting calculations.

Answer 1

0 1 Requirement (a) Calculation of Total Overhead Cost per unit on different alternatives Total Overhead Cost per unit Alternative- Alternative-Alternative- Alternative- Alternative- Alternative- Alternative- Alternative- Machine Hours Direct Labour hours La bour Overhead Overhead Variable Fixed Variable Fixed Variable Fixed Overhead Overhead Overhes Overhead |Overhead Overhead FGHel JoK F+K 19 Total

21 Calculations are shown as below Total Overhead Cost per unit Variable Fixed Machine Hours Direct Labour hours Labour Overhead Overhead Month Volume MachinDirect Variable Fixed VariableFixed Variable Fixed Overhead Overhead Overhea Overhead lOverhead Overhead НН -E25/825|-F 25/B25 | "E25/C25 | "F25/C25 |-e25/D25|-F25/D E26/B26 F26/B26 E27/B27F27/B27 E27/C27F27/C27E27/D27F27 -H25+125 | -H26+126 -125+K25 |-L25+M25 | -H25+K25 | 마125+M25| -125+125 | -125+L25 J25 M25K25 L25 8700 7500 18300 C26F26/C26E26/D26F26/D26 -E29/B29F29/B29 E29/C29F29/C29 E29/D29F29/D29H29+12929 K2929 M29-H29 K29H29 M29129 J29129 L29129 M29K29 L29 18100 -E31/B31 F31/B31 E31/C31-F31/C31 E31/D31F31/D31 -E32/B32-F32/B32-E32/C32-F32/C32 -E32/D32-F32/D32H32+132132+K32 -132+M32-H32+K32-H32 M32-132 132 132 L32132 M32-K32+L32 E33/B33F33/B33E33/C33F33/C33 E33/D33-F33/D33 -E34/B34F34/B34 E34/C34F34/C34E34/D34F34/D34 -E35/B35 -F35/B35E35/C35F35/C35E35/D35 F35/D35 8300 -H33+133 J34+M34K34+134 18200 8500 1400 Memorandum Chief Financial otficer In light of the subject of proper allocatiion of overhead cost, I would like to share that proper allocation of overhead cost helps in taking the best decision about the products growth. Allocation is done to recover the cost incurred for carrying the operations, improper allocation of cost may overvalue the product price which may later be disruptive for product continuity in the market So It is very much necessary to allocate the overnead cost properly. Best cost driver is that which allocates the overhead cost based on the activity consumed by the product. In the above data analysis, Best Cost driver will be allocation on the basis of Direct Labour hours since It depicts the lowest total overhead cost per unit.