Cost Analysis and Prediction

This assignment focuses on analyzing and predicting overhead costs. It involves comparing actual overhead figures to those predicted by a linear cost function at various activity levels (hours). The analysis highlights discrepancies between the actual and predicted values, demonstrating how overstatement and underestimation can occur. Additionally, the document explores the application of cost functions in decision-making, outlining steps involved in using them for informed choices within a business context.

MANAGEMENT ACCOUNTING 1
Management Account 1 Assignment
Student’s Name
Name of University

MANAGEMENT ACCOUNTING 2
Part A
A1: Total Cost Function for Each Category
The supplies used by Loose Tooth Incorporation are mixed. This indicates that they have a
fixed cost and a variable cost element. The high-low method is used to disaggregate the mixed
costs into fixed cost and variable costs components (Weygandt, Kimmel, $ Kieso, 2010). The
difference between the high and low level of costs are considered variable costs given that only
the variable cost element varies with the level of activity.
Step 1: Computation of the Variable Cost Using High-Low Method
Activity Level
Item High Low Change
Total Costs $ 175,099.00 $ 143,900.00 $ 31,199.00
Number of Visits 3,600 2,300 1,300
Variable Costs Per Visit $ 24.00
Step 2: Computation of the Fixed and Variable Cost of Supplies
Item 2014 2015 2016
Total Costs $ 143,900.00 $ 163,600.00 $ 175,099.00
Variable Costs $ 55,198.23 $ 71,997.69 $ 86,397.23
Fixed Costs $ 88,701.77 $91,602.31 $ 88,701.77
Ratio of Fixed Costs to Total Costs 0.62 0.44 0.51
Fixed Supplies Costs $ 2,404.01 $ 2,068.39 $2,583.56
Variable Supplies Costs $1,495.99 $2,631.61 $2,516.44
(i) Total Cost Function for Fixed Costs The total cost will be fixed at $ 110, 404.01,
$ 118,568.39, and 118, 382.56 during the respective years 2014, 2015, and 2016
regardless of the number of patient visits. The Fixed Cost function is
Y2014= $ 110,404.01
Y2015= $ 118,568.39

MANAGEMENT ACCOUNTING 3
Y2016=$118, 82.56
(ii) Total Cost Functions for Variable Costs. The variable cost is $24 per units produced; the
variable costs depend on the number of patient visits (X). Therefore the Total Cost
function using the variable costs is
Y = $24X
A2: Total Cost Function for Loose Tooth Inc
Y2014= $ 110,404.01 + $24X
Y2015= $ 118,568.39 + $24X
Y2016=$118, 82.56 +$24X
A3: Expected Profit in 2017
The average cost per visit for the three year is $ 60.46 as shown in the table below .
Cost Per Visit
2014 2015 2016 Average
$ 63.04 $ 60.00 $ 58.33 $ 60.46
The average cost per visit is used to compute the total revenue
Item 2017
Visits 3800
Fees $ 229,743.96
Total revenue $ 229,743.96
Expenses
Part-Time Dentist $ 43,000.00
Receptionist/Technician $ 80,000.23
Supplies $ 5,100.00
Rent $ 8,750.00
Administration $ 40,200.00
Total Expenses $ 175,099.00
Profit $ 54,644.96
Part B

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B1: Revenue as the Cost Driver
Regression Statistics
Multiple R 0.95664
R Square 0.91517
Adjusted R Square 0.90668
Standard Error 54.829
Observations 12
The computed R2 is 0.91517; the adjusted R2 is 0.90668 while the standard error is 54.829.
This indicates that the equation has excellent goodness of fit.
Coefficients
Standard
Error t Stat P-value
Lower
95%
Upper
95%
Lower
95.0%
Upper
95.0%
Intercept 245.62 87.71 2.80 0.02 50.19 441.05 50.19 441.05
Revenue 0.04 0.00 10.39 0.00 0.03 0.05 0.03 0.05
The coefficient of intercept is 245.62, t stat is 2.8 and p-value is 0.02 indicating the
coefficient is positive and statistically significant at the 5% confidence level. The coefficient for
revenue is 0.04, t-value is 10.39 and p-value = 0.00 indicating that the relationship between
revenue and cost is positive and statistically significant at the 5% confidence level.
B1a: Analysis of Whether the Fixed Cost is Greater Than 0
The cut-off t-value is 2.228, the t-value for the constant term a is 2.80. This is greater than
the cut-off t-value. The t-value analysis indicates that in the relevant range, the fixed cost is
significantly different from zero (Weygandt, Kimmel, $ Kieso, 2010).
B1b: Analysis of Whether the Variable Cost per Unit of the Cost Driver is Greater than
Zero

MANAGEMENT ACCOUNTING 5
The range for the coefficient b is 0.04 ± (2.228 *0.00) = 0.04 ± 0. This indicates that there is a
5% chance that the true value of the revenue coefficient lies outside the range. Given that 0 is
present in the confidence interval. It can be concluded that changes in the revenue do not affect
cost directly.
B1c: Analysis of how well the Cost Driver Explains the Behaviour in the Cost
The computed coefficient of determination is 0.91517. This implies that 91.517 % of the
variation in the dependent variable is due to the independent driver (cost driver). The cost drivers
explain the behaviour in the cost.
B2: Visits as the cost driver
Regression Statistics
Multiple R 0.422197091
R Square 0.178250383
Adjusted R Square 0.096075422
Standard Error 170.6469922
Observations 12
The computed R2 is 0.1783, and the computed Standard Error is 170.647.
Coefficients
Standard
Error t Stat P-value
Lower
95%
Upper
95%
Lower
95.0%
Upper
95.0%
Intercep
t 901.47 170.36 5.29 0.00
521.8
8
1281.0
7
521.8
8
1281.0
7
Visits 0.32 0.22 1.47 0.17 -0.17 0.81 -0.17 0.81
The intercept coefficient is 901.47; the standard error is 5.29, while the t-stat is 5.29.
The Visit coefficient is 0.32, the standard error is 0.22, and the t-stat is 1.47.
B2a: Analysis of Whether the Fixed Cost is Greater than Zero

MANAGEMENT ACCOUNTING 6
The cut-off t-value is 2.228, the t-value for the constant term a is 1.47 which is less than the
cut-off value. The t-value analysis indicates that in the relevant range, the fixed cost is not
significantly different from zero (Weygandt, Kimmel, $ Kieso, 2010).
B2b: Analysis of Whether the Actual Variable Cost Per Unit of Cost Driver is Greater than
Zero
The range for the visit coefficient is 0.32± (2.228x0.22) = 0.32 ± 0.22. The range is 0.1 –
0.54. The range appears in the confidence interval (5%) which indicates that changes in the
number of visits affect the cost.
B2c: Analysis of How well the Cost Driver Explains the Behaviour in the Cost
The computed coefficient of determination is 0.1783; this implies that 17.83 % of the
variation in the dependent variable is due to the independent driver (cost driver). For the
R2(coefficient of determination to be thought of as having passed the goodness of fit assessment,
it needs to be greater than or equal to 0.30) (Weygandt, Kimmel, $ Kieso, 2010). Given that
0.1783 is less than 0.30 then the goodness of fit test fails. However, this is not conclusive given
that the goodness of fit test sometimes includes independent variables that stimulate the increase
in R2. Therefore, the standard error is taken into consideration. The standard error indicates the
difference between the computed Y and the actual Y. The lower the value of the standard error,
the better is the goodness of fit and the prediction (Atkinson, Kaplan, Matsumura, & Young,
2012). The standard error is 0.22 implying that the independent variable adequately explains
variation in the dependent variable.
B3: Comparison of Revenue and Visits as Cost Drivers
Criteria Revenue as Cost Driver Visits as Cost Driver

MANAGEMENT ACCOUNTING 7
Economic Plausibility
There is a positive
relationship between revenue
and cost. This indicates that
the relationship is
economically plausible
There is a positive
relationship between visits
and cost. This indicates that
the relationship is
economically plausible.
Goodness of Fit
R-Square is 0.9152; the
standard error of regression is
54.83. This implies an
excellent goodness of fit
R-squared is 0.1783; the
standard error of regression
is 170.65. This implies
poor goodness of fit
Significance of the independent
variable
The t-value of 10.39 is
significant at the 0.05 level
The t-value of is 1.47
significant at the 0.05
significant level
Analysis of Estimation
Assumptions
The plot diagram indicates
that the assumption of
linearity, constant variance,
independence of residual and
normality of residuals hold
but the plot is made up of
only 12 observations
The plot diagram indicates
that the assumption of
linearity, constant variance,
independence of residual
and normality of residuals
hold but the plot is made up
of only 12 observations
Scatter Plot Diagram of Number of Visits as the Cost Driver
400 500 600 700 800 900 1000 1100 1200 1300 1400
$-
$200.00
$400.00
$600.00
$800.00
$1,000.00
$1,200.00
$1,400.00
$1,600.00
Number of Visits
Supplies Costs
Scatter Plot Diagram of Revenue as the Cost Driver

MANAGEMENT ACCOUNTING 8
$1,000.00 $6,000.00 $11,000.00 $16,000.00 $21,000.00 $26,000.00 $31,000.00
$-
$200.00
$400.00
$600.00
$800.00
$1,000.00
$1,200.00
$1,400.00
$1,600.00
Revenue
Supplies Costs
Both the cost functions are imperfect given that they are based on only 12 observations. For
the results to be considered reliable, Modesty needs to include more observations.
Part C
C1: Linear Cost Function
The linear Cost Function= a +b (number of hours)
Y = a + b (number of hours)
Where Y is the Overhead costs
Slope Coefficient (b) = Changes in Costs / Changes in Hours
= ($ 581,900- $374,000) / (7,700 – 3,300)
= $207,900 / 4,400 = $47.25 per Hour
Constant (a) = $374,000 - $47.25 per hour x 3,300 hours
= $ 374,000 - $ 155,925
= $218,075
Y= $218,075 + $47.25per hour (number of hours)
Scatter Plot Diagram

MANAGEMENT ACCOUNTING 9
3,000 4,000 5,000 6,000 7,000 8,000 9,000 10,000
$-
$100,000.00
$200,000.00
$300,000.00
$400,000.00
$500,000.00
$600,000.00
$700,000.00
Hours
Over Head Costs
C2: Fixed Cost
The Fixed cost is not represented by the computed constant (a=$ 218, 075) this is because the
relevant range of hours is 3,300 – 8, 800. The constant gives the most appropriate beginning
point for the straight line that estimates the manner in which the cost behave within the 3,300 –
8,800 range.
C3: Predicted Over Head Using Range
a b x Y
$ 218,075.00 $ 47.25 3,300 $374,000.00
$ 218,075.00 $ 47.25 4,400 $425,975.00
$ 218,075.00 $ 47.25 5,500 $477,950.00
$ 218,075.00 $ 47.25 6,600 $529,925.00
$ 218,075.00 $ 47.25 7,700 $581,900.00
$ 218,075.00 $ 47.25 8,800 $ 633,875.00
The table below gives a comparison of the actual over head and the predicted overhead. The
linear cost function is represented by Y= $218,075 + $47.25per hour (number of hours).
C4: Comparison of the Actual and Predicted Overhead

MANAGEMENT ACCOUNTING 10
Actual Over Head Predicted Overhead Difference
$ 374,000.00 $ 374,000.00 $ -
$ 440,000.00 $ 425,975.00 $ 14,025.00
$ 435,000.00 $ 477,950.00 $ (42,950.00)
$ 478,500.00 $ 529,925.00 $ (51,425.00)
$ 581,900.00 $ 581,900.00 $ -
$ 645,700.00 $ 633,875.00 $ 11,825.00
The predicted overhead overstates costs by $ 14,025 and $ 11,825 at the 4,400 and 8,800
hour levels respectively. The linear cost function understates the costs by $ 42,950 and 51,425 at
the 5,500 and 6,600 hour levels respectively.
Part D
In parts A, B, and C, the cost behaviour is discernible through the use of cost functions. The
cost function gives a mathematical analysis of the manner in which costs change when changes
occur in the level of activity relating to the cost. The when estimating cost function, it is assumed
that (i) changes in the level of a single activity (the cost driver) causes (explains) the changes in
the total costs; and (ii) cost behaviour can be estimated using linear cost functions which operate
within a given range (Donald, 2012). When making decisions using cost functions the managers
(i) identify the problem and uncertainty; (ii) obtain data about the possible cost drivers and the
factors that cause them to be incurred; (iii) make predictions about the future; (iv) using
accounting formulas and regressions to make decision; and implement the decision, evaluate
performance, and learn. The behaviour of Yuri is not determined by a discernible event, but
rather by preferences. Therefore, the choice of meal for tonight cannot be estimated. The choice
by Yuri cannot be measured which makes it difficult to evaluate the performance.
References

MANAGEMENT ACCOUNTING 11
Atkinson, A., Kaplan, R., Matsumura, E., & Young, S. (2012). Management accounting:
Information accounting for decision-making and strategy execution. Boston: Pearson.
Donald, J. (2012). Cost behaviour, Part two. On Target Direct. Retrieved from
https://owl.english.purdue.edu/owl/resource/560/10/
Horngen, C., Datar, S., & Rajan, M. (2012). Cost accounting: A managerial emphasis (14th ed.).
Boston: Prentice Hall.
Weygandt, J., Kimmel, P., & Kieso, D. (2010). Managerial accounting: Tools for business
decision making (5th ed.). Massachusetts: John Wiley & Sons Inc.