Regression analysis, activity-based costing, choosing cost drivers. Larry Chu, the plant controller at Rohan Plastics, wants to identify cost drivers for support overhead cost.

Indirect support consists of skilled staff responsible for the efficient functioning of all aspects (setup, production, maintenance, and quality control) ofthe plastic injection-moulding facility. In talking to the support staff, Chu has die impression that diey spend a good portion oftheir time ensuring that the equipment is set up correctly and checking that the first units of production in each batch are of good quality.

Chu has collected the following monthly data for the past 12 months:

Month Support Overhead Machine-Hours Number of Batches January $100,800 2,250 309 February 49,200 2,400 128 March 75,600 2,850 249 April 52,800 2,100 159 May 52,800 2,700 216 June 57,600 2,250 174 July 79,200 3,800 264 August 55,200 3,600 162 September 39,600 1,850 147 October 79,200 3,300 219 November 97,200 3,750 303 December 68,400 2,000 106 Total $807,600 32,850 2,436 Chu estimates the following regression equations:

y = $33,707 + ($12.27 X Machine-hours)

and y — $19,237 4- ($236.76 X Number of batches)

wherey is die monthly support overhead.

Required 1. Present plots of the monthly data and the regression lines underlying each of the follow¬

ing cost functions:

a. $upport overhead costs = a + (b X machine-hours)

b. $upport overhead costs = a + (b X number of batches)

Which cost driver for support overhead costs would you choose?

2. Chu anticipates 2,600 machine-hours and 300 batches will be run next month. Using the cost driver you chose in requirement 1, what support overhead costs should Chu budget?

3.

a. Chu adds 20% to costs as a first cut for determining target revenues (and hence prices).

Costs other than support overhead are expected to equal $150,000 next month.

Compare the target revenue numbers obtained if (i) machine-hours and (ii) number of batches is used as the cost driver. Discuss what would happen if Chu picked the wrong cost driver the cost driver other than the one you chose in requirement 1—to set target revenues and prices.

b. Describe any other implications of choosing the “wrong” cost driver and cost function.