Question

Adriana Corporation manufactures football equipment. In planning for next year, the managers want to understand the relation between activity and overhead costs. Discussions with the plant supervisor suggest that overhead seems to vary with labor-hours, machine-hours, or both. The following data were collected from last year's operations. Month Labor-Hours Machine-Hours Overhead Costs

1 3,625 6,775 $ 513,435

2 3,575 7,035 518,960

3 3,400 7,600 549,575

4 3,700 7,265 541,400

5 3,900 7,955 581,145

6 3,775 7,895 572,320

7 3,700 6,950 535,110

8 3,625 6,530 510,470

9 3,550 7,270 532,195

10 3,975 7,725 565,335

11 3,375 6,490 503,775

12 3,550 8,020 564,210

Required:

a. Use the high-low method to estimate the fixed and variable portions of overhead costs based on machine-hours.

b. Managers expect the plant to operate at a monthly average of 7,500 machine-hours next year. What are the estimated monthly overhead costs, assuming no inflation?

Answer 1

Answer- a)-Variable overhead cost per machine hour = $39.5 per hour.

Total fixed costs = $247420.

b)-The estimated overhead costs on 7500 machine hours for next year = $543670.

Explanation:-High-Low Method:-

Variable Cost per Unit

Variable cost per unit (b) is calculated using the following formula:

Variable cost per unit = (Y2-Y1)/(X2-X1)

Where,
y2 is the total cost at highest level of activity;
y1 is the total cost at lowest level of activity;
x2 are the number of units/miles/ labor ,machine hours etc. at highest level of activity; and
x1 are the number of units/miles/ labor, machine hours etc. at lowest level of activity

The variable cost per unit is equal to the slope of the cost volume line (i.e. change in total cost ÷ change in number of machine hours).

Total Fixed Cost

Total fixed cost (a) is calculated by subtracting total variable cost from total cost, thus:

Total Fixed Cost = (y2 – b)*x2 = (y1 – b*x1)

We have,
at highest activity: x₂ = 8020 machine hours; y₂ = $564210
at lowest activity: x₁ = 6490 machine hours; y₁ = $503775

Variable overhead cost per machine hour = ($564210 - $503775) /(8020 hours – 6490 hours)  

= $60435/1530 machine hours

= $39.5 per machine hour

Fixed overhead costs = $564210 - ($39.5 per machine hour*8020 hours)

= $564210 - $316790

= $247420

The estimated overhead costs on 7500 machine hours for next year = ($39.5 per machine hour*7500 hours)+ $247420

= $296250+$247420

= $543670