As a preliminary step in the selection of variables to use in a statistical-forecasting model, the management accountant has calculated the coefficient of correlation between the firm's sales and three economic indexes. The results were as follows: Which of the following statements indicates the best course of action for the auditor to take in the development of a forecasting model?

Question

As a preliminary step in the selection of variables to use in a statistical-forecasting model, the management accountant has calculated the coefficient of correlation between the firm's sales and three economic indexes. The results were as follows:  Which of the following statements indicates the best course of action for the auditor to take in the development of a forecasting model?

Quizplus · Accepted Answer

It is not necessary for a coefficient of correlation to be +1.0 for a statistically significant relationship. A high coefficient of correlation does indicate a strong relationship, but other factors such as sample size and significance level (p-value) also need to be considered.

Index C has the highest coefficient of correlation at 0.81, indicating a strong positive relationship with sales. Indexes A and B have lower coefficients of correlation, but they should not be dropped from consideration without further analysis.

Additionally, the negative coefficients of correlation for indexes B and C do not necessarily mean that they should be excluded from the model. Negative coefficients can still indicate a relationship, but in the opposite direction.

Therefore, the best course of action is to include index C in the model due to its relatively high coefficient of correlation, and to further analyze the relationships of the other two indexes before making a decision on whether or not to include them in the model.

As a Preliminary Step in the Selection of Variables to Use