Question

Regression; choosing among models (chapter appendix) Tilbert Toys (TT) makes the popular Floppin’ Freddy Frog and Jumpin’ Jill Junebug dolls in batches. TT has recently adopted activity-based costing. TT incurs setup costs for each batch of dolls that it produces. TT uses “number of setups” as the cost driver for setup costs.

TT has just hired Bebe Williams, an accountant. Bebe thinks that “number of setup hours” might be a better cost driver because the setup time for each product is different. Bebe collects the following data.

1. Estimate the regression equation for (a) setup costs and number of setups and (b) setup costs and number of setup hours. You should obtain the following results:

Regression 1: Setup costs = a + (b × Number of setups)

Regression 2: Setup costs = a + (b × Number of setup-hours)

2. On two different graphs plot the data and the regression lines for each of the following cost functions. 

 a. Setup costs = a + (b × Number of setups)

 b. Setup costs = a + (b × Number of setup hours)

3. Evaluate the regression models for “Number of setups” and “Number of setup-hours” as the cost driver according to the format of Exhibit 10-18.

4. Based on your analysis, which cost driver should Tilbert Toys use for setup costs, and why?

Answer 1

Regression; choosing among models. (chapter appendix)

1.    Solution Exhibit 10-38A presents the regression output for (a) setup costs and number of setups and (b) setup costs and number of setup-hours.

 

SOLUTION EXHIBIT 10-38A

Regression Output for (a) Setup Costs and Number of Setups and (b) Setup Costs and Number of Setup-Hours

 

2.    Solution Exhibit 10-38B presents the plots and regression lines for (a) number of setups versus setup costs and (b) number of setup hours versus setup costs.

 

SOLUTION EXHIBIT 10-38B

Plots and Regression Lines for (a) Number of Setups versus Setup Costs and (b) Number of Setup-Hours versus Setup Costs

 

3.

 

4.    The regression model using number of setup-hours should be used to estimate set up costs because number of setup-hours is a more economically plausible cost driver of setup costs (compared to number of setups). The setup time is different for different products and the longer it takes to setup, the greater the setup costs such as costs of setup-labor and setup equipment. The regression of number of setup-hours and setup costs also has a better fit, a significant independent variable, and better satisfies the assumptions of the estimation technique.

The regression model using number of setup-hours should be used to estimate set up costs because number of setup-hours is a more economically plausible cost driver of setup costs (compared to number of setups)