Adjusting data for use with regression; outlier Smeyer Industries is a large entity with more than 40 departments, each employing 35 to 100 persons.

Adjusting data for use with regression; outlier

Smeyer Industries is a large entity with more than 40 departments, each employing 35 to 100 persons. Recent experience suggests that the cost function used to estimate overhead in Department IP-14 is no longer appropriate. The current function was developed three years ago. Since then, a number of changes occurred in the facilities and processes used in Department IP-14. The changes happened one at a time. Each time a change was made, the cost accountant felt the change was not major enough to justify calculating a new overhead cost function. Now it is clear that the cumulative effect of the changes has been large.

You have been assigned the task to develop a new cost function for overhead in Department IP-14. Initial analysis suggests that the number of direct labour hours is an appropriate cost driver. Departmental records are available for nine months. The records reveal the following information.

An assistant has analysed the data for March through July and made the appropriate adjustments except for the following items (for which the assistant was unsure of the proper treatment).

                           (i)              The semi-annual property tax bill for Department IP-14 was paid on June 30. The entire amount of $3,000 was charged to overhead for June.

                         (ii)              The costs to install a new piece of equipment with a life of 10 years in the department were charged to overhead in April. The installation costs were $4,300.

                       (iii)              Factory depreciation is allocated to Department IP-14 every month. The department’s share, $8,000, is included in overhead.

                       (iv)              A strike closed the plant for three weeks in July. Several non-union employees were kept on payroll during the strike. Their duties were general housekeeping and 'busy work' These costs were charged to overhead.

You also have the details for the overhead account for the months of August and September. They are presented in the following table. You were hired on October 1 and have been keeping the department accounts since then. Therefore, you know that the data for October and November are correct, except for any adjustments needed for the preceding items.

Required

(a)          Using the information provided, adjust the monthly cost data to more accurately reflect the overhead costs incurred during each month.

(b)          Discuss whether the data for July should be included in the estimate of future costs. Use a scatter plot to help you answer this question.

(c)           Develop a cost function by regressing overhead costs in Department IP-14 on direct labour hours. Discuss whether your cost function would be reasonable for estimating future overhead costs. Ignore any items you will discuss in part (d).

(d)          Identify and discuss any additional adjustments that might be needed to more accurately measure overhead costs for the regression in part (c).

(e)           Explain why adjustments probably need to be made to information from accounting records when estimating a cost function.