The controller of Saratoga Auto Cylinder Company believes that the identification of the variable...

Question:

The controller of Saratoga Auto Cylinder 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

1. What is the meaning of ?200? and ?9? in the regression equation S = $200 + $9H.

2. Calculate the estimated cost of indirect materials if 900 machine hours are to be used during a month. (Assume that 900 falls within the relevant range for this cost equation.)

3. 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.

April August
Machine hours 1,050 820
Indirect materials:
   Beginning inventory $1,350 $2,100
   Ending inventory 1,900 4,100
   Purchases 7,000 7,300

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

4. Use the high-low method to estimate the behavior of the company's indirect-material cost. Express the cost behavior pattern in equation form. (Round variable cost per machine hour to 2 decimal places.)

5. What cost estimate would you recommend? High low or regression?

Cost Sheet:

The cost sheet is prepared under two methods mainly. These two methods are the absorption costing method and variable costing method. The absorption costing method is essential as per US GAAP. The variable costing method is followed for internal use purposes.

Answer and Explanation:

1. The meaning of $200 is that the $200 is a fixed cost and $9 denotes the per unit variable cost in the S = $200 + $9H.

2. The estimated cost of indirect materials if 900 machine hours are to be used during a month is $8,300 ($200 + $9 x 900).

3. The total indirect materials cost for April is $9,650 ($200 + $9 x 1,050) and for August is $7,580 ($200 + $9 x 820).


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Cost Allocation: Definition, Terms & Examples

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