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Regression, Activity-based Costing, Cost Drivers

Newroute Manufacturing has been using activity-based costing to determine the cost of produt X-678. One of the activities, "Inspection," ocbcurs just before the product is finished. newroute inspects every 10th unit, and has been using "number of units inspected" as the cost driver for inspection costs. A significant component of inspection costs is the cost of the test-kit used in each inspection.
Neela McFeen, the line manager,is wondering if inspection labor-hours might be a better cost driver for inspection cost. Neela gathers information for weekly inspection costs, units inspected, and inspection labor-hours as shown below:

Week Units Inspected Inspection Labor-Hours Inspection Cost
1 1,500 200 $3,900
2 500 80 2,000
3 1,800 240 4,700
4 2,500 250 6,000
5 2,200 220 5,500
6 800 90 2,600
7 1,000 120 3,100
Neela runs regressions on each of the possible cost drivers and estimates these cost functions:
Inspection Costs = $1,004 +($2.02 x Number of units inspected)
Inspection Costs = $626 + ($19.51 x Inspection labor-hours)

1) Explain why number of units inspected and inspection labor-hours are plausible cost drivers of inspection costs.

2) Plot the data and regression line for units inspected and inspection costs. Plot the data and regression line for inspection labor-hours and inspection costs. Which cost driver of inspection costs would you choose? Explain?

3) Neela expecst inspectors to work 150 hours next period and to inspect 1,200 units. Using the cost driver you chose in requirement 2, what amount of inspection costs should Neela budget? Explain any implications of Neela choosing the cost drive you did not choose in requirement 2 to budget inspection costs.

Solution Summary

Newroute Manufacturing has been using activity-based costing to determine the cost of product X-678. One of the activities, "Inspection," occurs just before the product is finished. Newroute inspects every 10th unit, and has been using "number of units inspected" as the cost driver for inspection costs. A significant component of inspection costs is the cost of the test-kit used in each inspection.
Neela McFeen, the line manager,is wondering if inspection labor-hours might be a better cost driver for inspection cost. Neela gathers information for weekly inspection costs, units inspected, and inspection labor-hours as shown below:

Week Units Inspected Inspection Labor-Hours Inspection Cost
1 1,500 200 $3,900
2 500 80 2,000
3 1,800 240 4,700
4 2,500 250 6,000
5 2,200 220 5,500
6 800 90 2,600
7 1,000 120 3,100
Neela runs regressions on each of the possible cost drivers and estimates these cost functions:
Inspection Costs = $1,004 +($2.02 x Number of units inspected)
Inspection Costs = $626 + ($19.51 x Inspection labor-hours)

1) Explain why number of units inspected and inspection labor-hours are plausible cost drivers of inspection costs.

2) Plot the data and regression line for units inspected and inspection costs. Plot the data and regression line for inspection labor-hours and inspection costs. Which cost driver of inspection costs would you choose? Explain?

3) Neela expecst inspectors to work 150 hours next period and to inspect 1,200 units. Using the cost driver you chose in requirement 2, what amount of inspection costs should Neela budget? Explain any implications of Neela choosing the cost drive you did not choose in requirement 2 to budget inspection costs.

$2.19