CarylCrates & Containers, Inc. (CCCI) The firm sells a wide range of containers that are used in the chemical and laboratory industry. One of the company's products is a heavy-duty corrosion-resistant metal drum, called the HVM drum, used to store hazardous volatile materials (HVM) considered toxic wastes. Utilization of a Constrained Resource; Make or Buy Production of the HVM drum is constrained by the capacity of an automated welding machine that is used to make precision welds. A total of 2,000 hours of welding time is available annually on the machine. Because each drum requires 0.4 hours of welding time, annual production is limited to 5,000 drums. At present, the welding machine is used exclusively to make the HVM drum. The Accounting Department has provided the following financial data concerning the HVM drum:
HVM DRUMS: Selling Price per drum.. Cost per drum: Direct Materials .P2,851.80 Direct Labor (P69.00 per hour) 196.80 Manufacturing Overhead ..... 245.80 Total Unit Manufacturing Costs ..- ..P 3,294.40 Unit Marketing and Admin Costs ...... 1.622.60 Margin Per Drum ..
P8,195.00
4 917.00 3,278.00
Management believes 6,000 HVM drums could be sold each year if the company had sufficient manufacturing capacity. As an alternative to adding another welding machine, management has considered buying additional drums from an outside supplier. Container Distributors Inc., a supplier of quality products, would be able to provide 4,000 HVM-type drums per year for P 7,621 per drum, which
CCCI's production manager, has suggested that the company could make better use of the welding machine by manufacturing classic-elite bike frames, which would require only 0.5 hours of welding time per frame and yet sell for far more than the drums. Conchita believes that CCCI could sell up to 1,600 classic-elite bike frames per year to bike manufacturers for P 13,112 each. The Accounting Department has provided the following data concerning the proposed new product: HVM Drums:
Proposed New Product (Classic Elite Bike Frames) Selling Price per frame Less: Cost per frame: Direct Materials .... .P5,420.00 Direct Labor (P69.00 per hour) . 1,600,00 Manufacturing Overhead 1.950.00 Total unit manufacturing costs P 8,970.00 Unit Marketing & Admin Costs ... 2.570.00 Margin per drum ..-
P13,112.00
11.540.00 P 1,572.00
The classic-elite bike frames could be produced with existing equipment and personnel. Manufacturing overhead is allocated to the products based on direct labor hours. Most of the manufacturing overhead consists of fixed common costs such as rent on the factory building, but some of it is variable. The variable manufacturing overhead has been estimated at P 73.75 per drum and P 97.50 per bike frame. The variable manufacturing overhead cost would not be incurred on drums acquired from an outside supplier. Selling and administrative expenses are allocated to the products based on revenues. Almost all of the selling and administrative expenses are fixed common costs, but it has been estimated that variable selling and administrative expenses amount to P 48.70 per drum and P 77.10 per bike frame.
All of the firm's employees - direct and indirect - are paid for full 40-hour workweeks and the company has a policy of laying off workers only in major recessions.
As soon as your analysis was shown to the top management team, several managers got into an argument concerning how direct labor costs should be treated when making this decision. One manager argued that direct labor is always considered as a variable cost in textbooks and in practice has always been considered as a variable cost at the company. After all, "direct" means you can directly trace the costs to products. "If direct labor is not a variable cost what is?"
Another manager argued just as strenuously that direct labor should be considered a fixed cost. No one had been laid off in over a decade, and for all practical purposes, everyone at the plant is on a monthly salary. Everyone classified as direct labor works a regular 40-hour workweek and overtime has not been necessary since the company adopted just-in-time techniques. Whether the welding machine is used to make drums or frames, the total payroll would exactly be the same. There is enough slack, in the form of idle time, to accommodate any increase in total direct labor time that the bike frames would require.
QUESTION: Based on the evidences and arguments, is direct labor in this case study variable or fixed? Please give justifications to your answer
