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CarylCrates & Containers, Inc. $($CCCl$)$ 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 is 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 $0\mathrm{.}4$ 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:

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 $P7,621$ per drum, which

$CCCl$ would resell to its customers at its normal selling after appropriate relabeling. Conchita Corazon,

CCCl$\text{'}$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 $0\mathrm{.}5$ 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 $P13,112$ 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

$P13,112\mathrm{.}00$

Direct Labor $($P$69\mathrm{.}00$ per hour$)$

P$5,420\mathrm{.}00$

Manufacturing Overhead

$1,600,00$

Total unit manufacturing costs

$P\frac{1,950,00}{8,970\mathrm{.}00}$

Unit Marketing & Admin Costs $...................2570\mathrm{.}00$

Margin per drum

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 $P73\mathrm{.}75$ per drum and $P97\mathrm{.}50$ per bike frame.

The variable manufacturing overhead cost would not be incurred on drums acquired from an outside

supplier. Selling ant 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 $P48\mathrm{.}70$ per drum and $P77\mathrm{.}10$ per bike frame.

All of the firm's emplovees $-$ direct and indirect $-$ are paid for full $40-$hour workweeks and the company

has a bolicy of laving off workers only in maior recessions.

As soon as your analysis was shown to the top management tea, several managers got into an argument

concernina how direct labor costs should be treated when makina 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, in "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 yariable

or fixed? Please give justifications to your answer

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