Using activity analysis, Arnoldson Company has identified the appropriate cost d
ID: 2424707 • Letter: U
Question
Using activity analysis, Arnoldson Company has identified the appropriate cost driver for maintenance costs in a factory as the number of machine hours. The maintenance costs have been observed as follows within the relevant range of 5,000 to 8,000 machine-hours.
Month Maintenance Cost Machine Hours
January $7,900 5,600
February $8,500 7,100
March $7,400 5,000
April $8,200 6,500
May $9,100 7,300
June $9,800 8,000
July $7,800 6,200
Required in an Excel spreadsheet:
1. Estimate the cost function using the high-low method. TC = FC + VC *X
2. If you were going to use the visual-fit method to estimate the cost function, what steps will you take?
3. Assume that Arnoldson Company would consider outsourcing their maintenance management to an outside contractor, who has exactly the same costs.
a. The contractor will charge $1.50 per hour based on the recorded machine hours. What is the contractors monthly breakeven point in machine hours and in dollars, based on the above cost function?
b. Another contractor (Contractor B) has put in a bid for the work. He proposes a flat fee of $5000 per month plus $1.00 per machine hour. Is this a better offer?
c. Contractor C proposes to do the work for a flat fee of $10000.
d. You are in charge of maintenance for Arnoldson Company. Your boss is getting impatient and wants to cut costs. He is expecting an update of your various proposals from contractors and is awaiting a recommendation from you. Explain your recommendation in a brief narrative format on your spreadsheet.
Explanation / Answer
1. Variable cost per machine hour = ($9,800 - $7,400) / (8,000 - 5,000) = $0.80 per machine hour
Fixed cost = $9,800 - ($0.80 × 8,000) = $3,400
Y = $3,400 + $0.80X
Where: Y = Total maintenance cost for a month
X = number of machine hours
2. We plot all the data points on a graph. The y-axis is cost and the x-axis is number of machine hours. We then draw a line through all the points, using judgment to fit the line as close as possible to all the plotted points. We extend the line until it intersects the y-axis of the graph.
The monthly fixed cost is equal to the point where the line intersects the y-axis or cost axis. To find the variable cost per machine hour, select any activity level and find the total cost at that activity level from the line. Then, subtract the fixed cost from the total cost, to yield variable cost. Finally, divide the variable cost by the units of activity to get the variable cost per unit of cost driver.
Difference: 2
LO: 3-4
AACSB: Analytic skills
Break-even Point: It is the point at which cost or expenses and revenue are equal: there is no net loss or gain, and one has "broken even." A profit or a loss has not been made, although opportunity costs have been "paid," and capital has received the risk-adjusted, expected return. It is shown graphically as the point where the total revenue and total cost curves meet. In the linear case the break-even point is equal to the fixed costs divided by the contribution margin per unit.
The break-even point is achieved when the generated profits match the total costs accumulated till the date of profit generation.
Outcome: Discuss and use various methods to estimate the variable and fixed costs portions of a mixed cost
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