Deriving Cost Drivers for Activity$-$Based Costing $($Regression Analysis$)$

Keywords

Cost drivers, Overhead Allocation, Activity$-$Based Costing, Regression

Decision$-$Making Context

The price of a product is often based on the cost of a product. The cost of a product can be expressed by the following formula:

Product Cost $=$ Direct Material Costs $+$ Direct Labor Costs $+$ Factory Overhead Costs

Direct costs are costs that can be tracked directly to a product. Examples include the raw materials to make a product and assembly line labor costs to produce the product. In addition to direct costs, making a product also requires overhead costs. Overhead costs are indirect costs that are generally hard to trace to an individual product. Overhead costs include taxes, rent, insurance, business permits, maintenance and repair of equipment, utilities $($electricity$,$ telephone$),$ and other factory costs.

Direct costs are generally easy to calculate because the company knows how much raw material is required to make a product as well as the direct labor cost to assemble a product $($required hours times the hourly labor rate$).$ Indirect costs, however, cannot be directly traced to a product. Thus, indirect costs are allocated to a product. It is important to allocate those costs to adequately price and evaluate the cost of producing a product for sale.

Many corporations use activity$-$based costing to allocate overhead costs. Activity$-$based costing $($ ABC $)$ assumes that the best way to assign indirect costs to products is based on the products' demand for resource$-$consuming activities, which we call cost drivers. In some sense, we are trying to make indirect costs come as close to direct costs as we can so that we can determine if we would make different decisions based on that cost allocation.

Bob's Delivery, a fictitious company, delivers bulk paper products to its customers. The business incurs various indirect costs, including car maintenance, tires, oil changes, gasoline, car insurance, and car property tax, that it would like to allocate to each delivery. If managers can more accurately allocate these indirect or overhead costs, then the business can more accurately charge its customers for their deliveries. Managers would like to estimate cost drivers as part of an activity$-$based costing system. In this lab, we use regression analysis to derive the cost drivers used in ABC $,$ and then we derive a costing formula using the cost drivers to allocate overhead for Bob's Delivery.

Required

Using regression analysis and choosing from several potential cost drivers, derive the cost drivers that are significant predictors of overall overhead costs and can be used to help allocate overhead. Set alpha to $5\%,$ or $0\mathrm{.}05.$

Derive the formula for allocating overhead $($the regression line equation$).$

Compare estimated overhead per delivery to actual overhead per delivery using a scatterplot.

Specify the Question

How can we use regression analysis to find cost drivers and derive a formula for allocating overhead?