Question

Variable and Fixed Costs, Cost Formula, High-Low Method

Li Ming Yuan and Tiffany Shaden are the department heads for the accounting department and human resources department, respectively, at a large textile firm in the southern United States. They have just returned from an executive meeting at which the necessity of cutting costs and gaining efficiency has been stressed. After talking with Tiffany and some of her staff members, as well as his own staff members, Li Ming discovered that there were a number of costs associated with the claims processing activity. These costs included the salaries of the two paralegals who worked full time on claims processing, the salary of the accountant who cut the checks, the cost of claims forms, checks, envelopes, and postage, and depreciation on the office equipment dedicated to the processing. Some of the paralegals’ time appears to vary with the routine processing of uncontested claims, but considerable time also appears to be spent on the claims that have incomplete documentation or are contested. The accountant’s time appears to vary with the number of claims processed.

Li Ming was able to separate the costs of processing claims from the costs of running the departments of accounting and human resources. He gathered the data on claims processing cost and the number of claims processed per month for the past 6 months. These data are as follows:

Month		Claims Processing Cost			Number of Claims Processed
February		$34,907			5,700
March		31,260			4,900
April		37,950			6,100
May		38,250			6,500
June		44,895			7,930
July		44,055			7,514

Required:

1. Classify the claims processing costs that Li Ming identified as variable and fixed.

Salaries of the two paralegals times the percentage of time spent in processing uncontested claims
Salaries of the two paralegals times the percentage of time spent in handling contested claims
Depreciation on office equipment used in claims processing activity
Salary of the accountant times the percentage of time spent in the claims processing activity
Cost of claims forms
Checks
Envelopes
Postage

2. What is the independent variable?

What is the dependent variable?

3. Use the high-low method to find the fixed cost per month.
$

Use the high-low method to find the variable rate. Round to two decimal places.
$ per claim

What is the cost formula?
Total cost of claims processing = $ + ( $ per unit ×   )

4. Conceptual Connection: Suppose that an outside company bids on the claims processing business. The bid price is $4.60 per claim. If Tiffany expects 75,600 claims next year, should she outsource the claims processing or continue to do it in-house?

Answer 1

1. Variable costs—salary of the two paralegals times the percentage of time spent in processing uncontested claims; salary of the accountant times the percentage of time spent in this activity; cost of claims forms, checks, envelopes, and postage.

Fixed costs—salaries of the two paralegals times the percentage of time spent in handling contested claims, depreciation on office equipment used in claims processing activity.

2. The independent variable is number of claims; the dependent variable is cost of claims processing.

3. The low point is March with $31,260 cost and 4,900 claims; the high point is June with $44,895 cost and 7,930 claims.

Variable rate = ($44,895 – $31,260)/(7,930 – 4,900)

= $13,635/3,030 claims

= $4.50 per claim

Using the high point:

Fixed cost = $44,895 – $4.50(7,930) = $9,210

Total cost of claims processing = $9,210 + ($4.50 × Claims)

4. Cost of outsourcing = $4.60(75,600) = $347,760

Cost of processing in house = 12($9,210) + $4.50(75,600)

= $110,520 + $340,200

= $450,720

Tiffany should outsource the claims processing for a savings of $102,960 ($450,720 – $347,760).