Mixed Cost Analysis and the Relevant Range
The Ramon Company is a manufacturer that is interested in developing a cost formula to estimate the fixed and variable components of its monthly manufacturing overhead costs. The company wishes to use machine-hours as its measure of activity and has gathered the data below for this year and last year:
| Last Year | This Year | ||
Month | Machine-Hours | Overhead Costs | Machine Hours | Overhead Costs |
January | 21,000 | $84,000 | 21,000 | $86,000 |
February | 25,000 | $99,000 | 24,000 | $93,000 |
March | 22,000 | $89,500 | 23,000 | $93,000 |
April | 23,000 | $90,000 | 22,000 | $87,000 |
May | 20,500 | $81,500 | 20,000 | $80,000 |
June | 19,000 | 575,500 | 18,000 | $76 ,500 |
July | 14.000 | $70,500 | 12,000 | $67,500 |
August | 10,000 | $64,500 | 13,000 | $71,000 |
September | 12,000 | 569,000 | 15.000 | $73,500 |
October | 17,000 | $75,000 | 17,000 | $72,500 |
November | 16.000 | 571,500 | 15,000 | $71,000 |
December | 19,000 | $78,000 | 18,000 | $75,000 |
The company leases all of its manufacturing equipment. The lease arrangement calls for a flat monthly fee up to 19.500 machine-hours. If the machine-hours used exceeds 19.500. then the fee becomes strictly variable with respect to the total number of machine-hours consumed during the month. Lease expense is a major element of overhead cost.
Required:
1. Using the high- low method. estimate a manufacturing overhead cost formula.
2. Prepare a scattergraph using all of the data for the two-year period. Fit a straight line or lines to the plotted points using a ruler. Describe the cost behavior pattern revealed by your scattergraph plot.
3. Assume a least-squares regression analysis using all of the given data points estimated the total fixed costs to be $40.102 and the variable costs to be $2.13 per machine-hour.Do you have any concerns about the accuracy of the high-low estimates that you have computed or the least-squares regression estimates that have been provided?
4. Assume that the company consumes22,500 machine-hours during a month. Using the high low method, estimate the total overhead cost that would be incurred at this level of activity. Be sure to consider only the data points contained in the relevant range of activity when performing your computations.
5. Comment on the accuracy of your high-low estimates assuming a least-squares regression analysis using only the data points in the relevant range of activity estimated the total fixed costs to be $10.090 and the variable costs to be $3.53 per machine-hour.
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