eBook (Appendix 3A) Scattergraph, High-Low Method, Method of Least Squares, Use of Judgment The management of Wheeler Company has decided to develop cost formulas for its major overhead activities. Wheeler uses a highly automated manufacturing process, and power costs are a significant manufacturing cost. Cost analysts have decided that power costs are mixed. The costs must be broken into their fixed and variable elements so that the cost behavior of the power usage activity can be properly described. Machine hours have been selected as the activity driver for power costs. The following data for the past 8 quarters have been collected: Quarter 1 Machine Hours Power Cost 20,000 $26,000 25,000 38,000 30,000 42,500 22,000 37,000 21,000 34,000 18,000 29,000 24,000 36,000 40,000 7 B 28,000 Note: For the following requirements, round the fixed cost to the nearest dollar, round the variable rates to three decimal places, and the R to two decimal places. Required: 1. Prepare a scattergraph by plotting power costs against machine hours. Does the scattergraph show a linear relationship between machine hours and power cost? Yes 2. Using the high and low points (e, the high-low method), compute a power cost formula. (Note: Round variable rate to three decimal places.) Total power cost 1 1,250 X (1 1,375 X x Number of machine hours) 3. Use the method of least squares to compute a power cost formula. Evaluate the coefficient of determination. Variable rate (to two decimal places) Fixed cost (to the nearest dollar) Coefficient of determination (2) (to one decimal place). per machine hour 6,900 4. Conceptual Connection: Rerun the regression, and drop the point (20,000, $26,000) as an outlier. Compare the results from this regression to those for the regression in Requirement 3. Which is better? This regression looks better in terms of R squared. Check My Wo 1. A scattergraph shows cost relationship, general behavior and outliers, which may not be normal behavior. Prepare the graph with power cost on the vertical axis and number of machine hours on the horizontal axis. Look at the relationship to the power cost to the amount of machine hours. 2. Determine the highest and lowest levels, based on activity. Take the difference between the corresponding costs with the selected levels, and then divide this by the difference between the highest and lowest activity levels (units). This results in the variable rate. Multiply the variable rate by either the high or low activity level of units. This is the variable cost. Subtract the variable cost from the total cost to determine the fixed cost. Construct a cost formula using the fixed cost and variable rate multiplied by the number of machine hours (x).