C3.42 LO 3.9 Interpreting regression analysis; activity-based costing: service firm Greenscape Pty Ltd provides commercial landscaping services. Linda Drake, the firm's owner, wants to develop cost estimates that she can use to prepare bids on jobs. After analysing the firm's costs, Drake has developed the following preliminary cost estimates for each 1000 square metres of landscaping: Direct materials Direct labour (5 direct labour hours @ $19 per hour) Overhead (@ $18 per direct labour hour) Total cost per 1000 square metres $400 95 90 $585 Drake is quite certain about the estimates for direct materials and direct labour, but she is not as comfortable with the overhead estimate. As Indirect costs, overhead costs cannot be traced directly to landscaping. Instead, Drake has used a common method of estimating an overhead rate per direct labour hour. However, the estimate for overhead is based on the overhead costs that were incurred during the past 12 months, as presented in the following schedule. The estimate of $18 per direct labour hour was determined by dividing the total overhead costs for the 12-month period ($648000) by the total direct labour hours (36000).

Drake believes that overhead is affected by total monthly direct labour hours. She decided to perform a regression analysis of overhead (OH) on total direct labour hours (DLH). The following regression formula was obtained: OH $26 201+ $9.27DLH Required 1. The overhead rate developed from the regression analysis is different from Linda Drake's preliminary estimate of $18 per direct labour hour. Explain the difference in the two overhead rates. 2. Using the overhead formula that was derived from the regression analysis, determine a total variable cost estimate for each 1000 square metres of landscaping. 3. Linda Drake has been asked to submit a bid on a landscaping project for Melbourne City Council, consisting of 50000 square metres. Drake estimates that 30 per cent of the direct labour hours required for the project will be on overtime. Calculate the variable costs per 1000 metres of landscaping that should be included in any bid that Drake would submit on this project. Use the overhead formula derived from the regression analysis. 4. Should Greenscape rely on the overhead formula derived from the regression analysis as the basis for the variable overhead component of its cost estimate? Explain your answer.

5. After attending a seminar on activity-based costing, Drake decided on a further analysis of Greenscape's activities and costs. She discovered that a more accurate portrayal of the firm's cost behaviour could be achieved by dividing overhead into three separate cost pools-administration, seeding and individual planting-each with its own cost driver. After discussions with some of the landscapers who work within the firm, Drake came to the conclusion that possible cost drivers for each of these cost pools were direct labour hours, the number of square metres of turf seeded, and the number of individual trees and shrubs planted, respectively. A separate regression equation was estimated for each overhead cost pool, with the following results: Administration OH = $10 000+ $4.10DLH where DLH denotes direct labour hours; Seeding OH = $9 100 + $13.50STS where STS denotes the number of square metres of turf seeded (in thousands); Planting OH = $8000+ $6.60TSP where TSP denotes the number of individual plantings (such as trees and shrubs). Assume that 5 direct labour hours are needed to landscape each 1000 square metres, regardless of the specific planting material that is used.

(a) Suppose the landscaping project for the city will involve seeding all 50000 square metres of turf and planting 70 trees and shrubs. Calculate the variable overhead cost that Drake should include in the bid.

(b) Recalculate the variable overhead cost for the city's landscaping project, assuming that half of the 50000 square metre landscaping area will be seeded and there will be 230 individual plantings.

(c) Explain why the costs differ in parts

(a) and (b).

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Month Total overhead Regular direct labour hours Overtime direct Total direct labour labour hours* hours January $ 54000 2910 190 3100 February 47000 2380 20 2400 March 48000 2210 40 2250 April 56000 2590 210 2800 May 57 000 3030 470 3500 June 65000 3240 760 4000 July 64000 3380 620 4000 August 56000 3050 350 3400 September 53000 2760 40 2800 October 47000 2770 30 2800 November 47000 2120 30 2150 December Total 54000 2560 240 2800 $648000 33000 3000 36000 *The overtime premium is 50 per cent of the direct labour wage rate.