Methods of Cost EstimationAccount Analysis, Simple and Multiple Regression: Mountain View Outdoor Products Corporation has prepared a
Question:
Methods of Cost Estimation—Account Analysis, Simple and Multiple Regression: Mountain View Outdoor Products Corporation has prepared a schedule of estimated overhead costs for the coming year. This schedule was prepared on the assumption that production would equal 80,000 units. Costs have been classified as fixed or variable according to the judgment of the controller. The following overhead items and the classification as fixed or variable form the basis for the overhead cost schedule:
In the past, the overhead costs have been related to production levels. However. price instability has led management to suggest that explicit consideration be given to including an appropriate price index in the cost equation. While management realizes that to estimate future costs using a regression model that includes both production and a price index as independent variables requires predicting a future value not only for production but for the price index as well, at least some recognition would be given to the dramatic price changes that have been experienced in the past few years. For cost-estimation purposes, it is assumed that the next value of the index will be the same as the last period value of the index. Following management instructions, data were gathered on past costs, production levels, and an appropriate price index. These data are:
There have been no significant changes in operations over the period covered by these data nor are there any significant changes expected in the coming period. When the data above were entered into a regression program using only the production level as the independent variable, the following results were obtained:
When both predictors were entered in the regression program, the following results were obtained:
Required:
a. Prepare a cost-estimation equation using the account analysis approach.
b. Use the high-low method to prepare a cost estimate for the activity expected in the coming period.
c. Prepare a cost estimate using simple linear regression.
d. Use the multiple regression results to prepare an estimate of overhead costs for the coming period.
e. Comment on which method you think is more appropriate under the circumstances.
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