Problem 5A8 HighLow Method Predicting Cost LO510 Nova Compan

Problem 5A-8 High-Low Method; Predicting Cost [LO5-10]

Nova Company’s total overhead cost at various levels of activity are presented below:

Assume that the total overhead cost above consists of utilities, supervisory salaries, and maintenance. The breakdown of these costs at the 41,000 machine-hour level of activity is:

Nova Company’s management wants to break down the maintenance cost into its variable and fixed cost elements.

Required:

1. Estimate how much of the $228,560 of overhead cost in July was maintenance cost. (Hint: to do this, it may be helpful to first determine how much of the $228,560 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 in the form Y = a + bX.

3. Express the company’s total overhead cost in the form Y = a + bX.

4. What total overhead cost would you expect to be incurred at an activity level of 46,000 machine-hours?

Solution

1. Estimate how much of the $228,560 of overhead cost in July was maintenance cost. (Hint: to do this, it may be helpful to first determine how much of the $228,560 consisted of utilities and supervisory salaries. Think about the behavior of variable and fixed costs.)

So Maintenance cost is $88260

2) Variable cost per machine hour = (88260-56460)/(71000-41000) =1.06 per machine hour

Fixed cost = 88260-(71000*1.06) = 13000

Y = a+bx

Y = 13000+1.06X

3) Y = a+bx

Y = 61000+2.36X

4) Total overhead cost = (46000*2.36)+61000 = $169560