PROBLEM 2-20 High-Low Method; Predicting Cost [LO 2-4, LO 2-5 Nova Company\'s to

Question

PROBLEM 2-20 High-Low Method; Predicting Cost [LO 2-4, LO 2-5 Nova Company's total overhead cost at various levels of activity are presented below: Total Month Machine-Hours Overhead Cost May.. June July 70,000 60,000 80,000 90,000 $198,000 $174,000 $222,000 $246,000 Assume that the total overhead cost above consists of utilities, supervisory salaries, and main- tenance. The breakdown of these costs at the 60,000 machine-hour level of activity is: Utilities (variable) he $ 48,000 21,000 105,000 $174,000 . Maintenance (mixed).. Total overhead cost.._. . . . Nova Company's management wants to break down the maintenance cost into its variable and fixed cost elements. Required: 1. Eštimate how much of the $246,000 of overhead cost in July was maintenance cost. (Hint: to do this, it may be helpful to first determine how much of the $246.000 consisted of utilities and supervisory salaries. Think about the behavior of variable and fixed costs!) 2. Using the high-low method, estimate a cost formula for maintenance. 3. Express the company's total overhead cost in the linear equation form Y a + bX. 4. What total overhead cost would you expect to be incurred at an activity level of 75,000 machine-hours?

Explanation / Answer

1. Maintenance cost: $153000

Note: Utilities being variable in nature will change in proportion to the level of activity. Supervisory salaries being fixed remain unchanged at both levels while maintenance which is a mixed cost is the balancing amount at the 90000 machine-hours activity level.

2. Cost formula for maintenance cost: Y = $9000 + $1.60X

3. Cost formula for total overhead cost: Y = $30000 + $2.40X

4. Total overhead cost at 75000 machine hours activity level = $30000 + ($2.40 x 75000) = $30000 + $180000 = $210000

Machine-hours 60000 90000 Utilities (variable) 48000 72000 ($48000/60000 x 90000) Supervisory salaries (fixed) 21000 21000 Maintenance (mixed) 105000 153000 Total overhead cost $ 174000 246000

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