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In: Accounting

Discuss how it should be evaluated whether the cost driver hours is the best cost driver...

Discuss how it should be evaluated whether the cost driver hours is the best cost driver for estimating the cost function.

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Expert Solution

In many cases, the choice of a cost driver is aided substantially by understanding both oper ations and cost accounting.

To see why understanding operations is needed, consider the costs to maintain and repair metal-curting machines at Helix Company Ltd., a manufacturer of treadmills.

Helix schedules repairs and maintenance at a time when production is at a low level to avoid having to take machines out of service when they are needed most. An analysis of the monthly data will then show high repair costs in months of low production and low repair costs in months of high production. Someone unfamiliar with operations might conclude that there is an inverse relationship between production and repair costs. The engineering link between units produced and repair costs, however, is usually clear-cut.

Over time, there is a cause-and-effect relationship: the higher the level of production, the higher the repair costs. To estimate the relationship correctly, operating managers and analysts will recognize that repair costs will tend to lag behind periods of high product tion, and hence, they will use production of prior periods as the cost driver.

In other cases, choosing a cost driver is more subtle and difficult. Consider again india rect manufacturing labor costs at Elegant Rugs. Management believes that both the num ber of machine-hours and the number of direct manufacturing labor-hours are plausible cost drivers of indirect manufacturing labor costs. However, management is not sure which is the better cost driver.


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