Case 6-50 Interpreting Least-Squares Regression; Landscaping Service; Activity-Based Costing LO 6-1, 6-2, 6-5) Earth and Artistry, Inc., provides commercial landscaping services. Sasha Cairns, the firm's owner, wants to develop cost estimates that she can use to prepare bids on jobs. After analyzing the firm's costs, Cairns has developed the following preliminary cost estimates for each 1,000 square feet of landscaping. Direct material $400 Direct labor (5 direct-labor hours at $10 per hour) Overhead (at $18 per direct-labor hour) 50 90 $540 Page 279 Total cost per 1,000 square feet Cairns is quite certain about the estimates for direct material and direct labor. However, she is not as comfortable with the overhead estimate. 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-labor hour was determined by dividing the total overhead costs for the 12-month period ($648,000) by the total direct-labor hours (36,000). Regular Direct- Overtime Direct- Total Direct- January February Total Overhead $ 54,000 Labor Hours Labor Hours* Labor Hours 2,910 190 3,100 47,000 2,380 20 2,400 March 48,000 2,210 40 2,250 April 56,000 2,590 210 2,800 May 57,000 3,030 470 3,500 June 65,000 3,240 760 4,000 July 64,000 3,380 620 4,000 August 56,000 3,050 350 3,400 September 53,000 2,760 40 2,800 October 47,000 2,770 30 2,800 November 47,000 2,120 30 2,150 December 54,000 2,560 240 2,800 Total $648,000 33,000 3,000 36,000 *The overtime premium is 50 percent of the direct-labor wage rate. Cairns believes that overhead is affected by total monthly direct-labor hours. Cairns decided to perform a least-squares regression of overhead (OH) on total direct-labor hours (DLH). The following regression formula was obtained. 1. Use the high-low method to estimate the cost behavior for the clinic's administrative costs. Express the cost behavior in formula form (Y=a+bX). What is the variable cost per patient? 2. Build a spreadsheet: Construct an Excel spreadsheet and use the Excel commands to perform a least-squares regression and estimate the administrative cost behavior. Express the cost behavior in formula form. What is the variable cost per patient? Compute and interpret the R value for the regression. 3. Write a memo to the hospital administrator comparing the cost estimates using (a) least-squares regression, (b) the high-low method, and (c) the scatter diagram and visually fit semivariable-cost line from the preceding case (requirement 4). Make a recommendation as to which estimate should be used, and support your recommendation. Make any other suggestions you feel are appropriate. 4. After receiving the memo comparing the three cost estimates, Mahoney called McDonough to discuss the matter. The following exchange occurred. Mahoney: "As you know, Megan, I was never in favor of this clinic. It's going to be a drag on our administrative staff, and we'd have been far better off keeping the pediatrics operation here in the hospital." McDonough: "I was aware that you felt the clinic was a mistake. Of course, the board of trustees had other issues to consider. I believe the board felt the clinic should be built to make pediatric care more accessible to the economically depressed area on the other side of the city." Mahoney: "That's true, but the board doesn't realize how difficult it's going to make life for us here in the hospital. In any case, I called to tell you that when you and I report to the board next week, I'm going to recommend that the clinic be shut down. I want you to support my recommendation with one of your cost estimates showing that administrative costs will soar at high activity levels." McDonough: "But that estimate was based on the high-low method. It's not an appropriate method for this situation." Mahoney: "It is an estimate, Megan, and it's based on a well-known estimation method. This is just the ammunition I need to make the board see things my way." McDonough: "I don't know, Jeff. I just don't think I can go along with that." Mahoney: "Be a team player, Megan. I've got a meeting now. Got to run." That night McDonough called to discuss the matter with her best friend, you. What would you advise her