Echeverria SA is an Argentinian manufacturing company whose total factory overhe

Question

Echeverria SA is an Argentinian manufacturing company whose total factory overhead costs fluctuate somewhat from year to year according to the number of machine-hours worked in its production facility. These costs (in Argentinian pesos) at high and low levels of activity over recent years are given below:



Level of Activity
Low High
Machine-hours 49,500 66,000
Total factory overhead costs 252,050 pesos 283,400 pesos

The factory overhead costs above consist of indirect materials, rent, and maintenance. The company has analyzed these costs at the 49,500 machine-hours level of activity as follows:


Indirect materials (variable) 74,250 pesos
Rent (fixed) 128,000
Maintenance (mixed) 49,800

Total factory overhead costs 252,050 pesos


For planning purposes, the company wants to break down the maintenance cost into its variable and fixed cost elements.

Required:
1.

Estimate how much of the factory overhead cost of 283,400 pesos at the high level of activity consists of maintenance cost. (Hint: To do this, it may be helpful to first determine how much of the 283,400 pesos cost consists of indirect materials and rent. Think about the behavior of variable and fixed costs.) (Do not round intermediate calculations. Omit the "pesos" sign in your response.)

Maintenance cost at high level of activity pesos

2.

Using the high-low method, estimate a cost formula for maintenance. (X represent per machine-hour.) (Round the "Variable cost per machine-hour" to 2 decimal places and "Fixed cost" to the nearest whole number. Omit the "pesos" sign in your response.)

Y = pesos + peso X

3.

What total overhead costs would you expect the company to incur at an operating level of 54,450 machine-hours? (Do not round intermediate calculations. Omit the "pesos" sign in your response.)

Total factory overhead cost pesos

Explanation / Answer

Direct costs are the ones that are charged directly into production. They are usually things that can easily be determined to belong to a specific job or product. Indirect costs are usually ones that are harder to trace back to a specific job or product, or it's just not worth the time to do so. It's easier to use some examples. Let's say you make lawnmowers. The main pieces of that lawnmower would be the direct costs, such as the housing, the motor, the four wheels, the handle, the blades, etc. You could easily know that each of those items goes into one lawnmower and account for it directly. The indirect things would be like screws, glue, oil, etc. Picture that you have 100 lawnmowers being made, and each of those direct materials is sitting right there at the place where the lawnmower is being assembled. But off to the side somewhere is just this big bin of screws. So everyone making a lawnmover just grabs a big handful of screws and takes it to their little work area. No one would want to bother figuring out how many screws are going to each lawnmower. Or how much oil is going to each lawnmower, etc. Even if they know, it's certainly not worth messing with dividing the cost of thousands of screws purchased down into the cost of one lawnmower. As a general rule, hardware (screws, bolts, etc), paint, oil and the like are going to be indirect materials. The "main" pieces of a product would be the direct materials. You also have to keep in mind that this can be opinionated. Some items are fairly obvious and some items are ambiguous. (Even financial accounting has differences of opinion and things that are not always cut and dry, but cost accounting is even more so like this.) Direct and indirect labor is a little easier to figure out. Generally, the people working directly on the product, the assembly line people, are the direct. A lot of times these are hourly people. The indirect labor is like the supervisors, quality control people, etc, many times those on salary. A supervisor cannot really be tracked to a particular job or product. They're just there. All of the direct costs will be charged directly into production, to either the job or the product line. Indirect costs are put into an overhead account, and then later it's divided up among all jobs or products at one time, so that it's kind of done all in one step rather than tracking each individual item. How that's done is another subject.

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