Reference no: EM13512952

The Ramon Company manufactures a wide range of products at several different plant locations. The Franklin plant, which manufactures electrical components, has been experiencing some difficulties with fluctuating monthly overhead costs. The fluctuations have made it difficult to estimate the level of overhead that will be incurred for any one month. Management wants to be better able to estimate overhead costs accurately in order to plan its operations and financial needs. A trade association publication to which Ramon Company subscribes indicates that for companies that manufacture electrical components, overhead tends to vary with direct labor hours. One member of the accounting staff proposes that the cost behavior pattern for overhead costs be determined. Then, overhead costs could be predicted from the budgeted direct labor hours. Another member of the accounting staff suggests that a good starting point for determining the cost behavior patterns of overhead costs would be an analysis of historical data. The historical cost behavior pattern would provide a basis for determining the cost behavior pattern. The methods proposed for this purpose are the high-low method and simple linear regression. Data on direct labor hours and the respective overhead costs incurred were collected for the past two years. The raw data follow:

19a	Direct Labor Hours x	Overhead Costs y
January	20,000 hours	$84,000
February	25,000	99,000
March	22,000	89,000
April	23,000	90,000
May June July August September October November December	20,000 19,000 14,000 10,000 12,000 17,000 16,000 19,000	81,000 75,000 70,000 64,000 69,000 75,000 71,000 78,000

19b	Direct Labor Hours x	Overhead Costs y
January	21,000 hours	$86,000
February	24,000	93,000
March	23,000	87,000
April	22,000	80,000
May June July August September October November December	20,000 18,000 12,000 13,000 15,000 17,000 15,000 18,000	76,000 67,000 71,000 73,000 72,000 71,000 75,000 78,000

Using linear regression, the following data were obtained:

Coefficient of determination (r2) 0.9109

Coefficient of regression equation

Constant 39,859

Independent variable 2.1549

Standard error of the estimate (s,) 2,840

Standard error of the regression coefficient for the independent variable (sb) 0.1437

Table t-statistic for a 95% confidence interval (when n -2 = 24 -2 = 22) 2.074

(a) Using the high-low method, determine the cost behavior pattern of the overhead costs for the Franklin plant.

(b) Using the results of the regression analysis, calculate the estimate of overhead costs for 22,500 direct labor hours.

(c)Of the two proposed methods, which one should Ramon Company employ to determine the historical cost behavior pattern of the Frankliin plant's overhead costs? Explain your answer completely, indicating the reasons why the other method should not be used.

(CMA, adapted)

Enrollment in local colleges, 2005