Question

Modelling Cost Behaviour

MEW has been contracted by one of its customers to produce two new components in the next year. The management accountant has been asked to prepare costings for the two new components and is concerned that the current method of calculating the overhead cost per unit is not accurate enough. She has collected monthly information for the current year on the fixed and variable overheads incurred and on potential alternative allocation bases that can be used to calculate the total overhead cost per unit.

Month	Volume	Machine Hours	Direct Labour (Machinists and Assembly only) Hours	Variable Overhead Costs	Fixed Overhead Costs
1	1,200	810	3,500	$ 7,700	$ 18,000
2	1,200	830	3,700	$ 8,700	$ 17,500
3	1,400	920	4,000	$ 9,500	$ 18,300
4	1,300	935	3,800	$ 9,000	$ 18,000
5	1,350	910	4,100	$ 9,800	$ 18,500
6	1,300	860	3,900	$ 9,000	$ 18,100
7	1,400	920	4,050	$ 9,600	$ 19,000
8	1,500	950	4,400	$ 9,700	$ 19,000
9	1,250	820	3,500	$ 8,300	$ 17,900
10	1,400	880	4,033	$ 9,100	$ 19,000
11	1,300	887	3,800	$ 8,600	$ 18,200
12	1,400	945	4,150	$ 9,800	$ 18,500
Total	16,000	10,667	46,933	$ 108,800	$ 220,000

Required:

1. (a) Use the data provided to identify which of the three potential cost drivers (or combination of cost drivers) should be used to estimate the total overhead cost per unit. Prepare a regression analysis using the cost driver(s) you have selected (you may want to look at scatterplots and prepare alternative regression equations to make your decision).

2. (b) Prepare a memo for the CFO that explains (i) why it is necessary to use a more accurate method of allocating overheads for determining the total cost of the new components and (ii) explains how you decided which cost drivers to include in your regression. You should add supporting evidence and/or calculations to show how you came to your conclusion. Also, write out your annual total overhead cost equation using your regression results. Note the CFO requests a memo of no more than one page (within specified margins and font size) excluding any regression results or supporting calculations.

Answer 1