Target Costing Question using High-Low Method

Can you please assist me with my query. I would really appreciate it 🙂

Here’s the full question below:

Example 3 Edward Ltd:

A selling price of $44 has been set in order to compete with a similar radio on the market that has comparable features to Edward Ltd’s intended product. The board has agreed that the acceptable margin (after allowing for all production costs) should be 20%.

Cost information for the new radio is as follows:

Component 1 (Circuit-board) – these are bought in and cost $4.10 each. They are bought in batches of 4,000 and additional delivery costs are $2400 per batch.

Component 2 (Wiring) – in an ideal situation 25 cm of wiring is needed for each completed radio. However, there is some waste involved in the process as wire is occasionally cut to the wrong length or is damaged in the assembly process. Edward Ltd estimates that 2% of purchased wire is lost in the assembly process. Wire costs $0.50 per metre to buy.

Other material – other materials cost $8.10 per radio.

Assembly labour – these are skilled people who are difficult to recruit and retain. Edward ltd has more staff of this type than needed but is prepared to carry this extra cost in return for the security it gives the business. It takes 30 minutes to assemble a radio and the assembly workers are paid £12.60 per hour. It is estimated that 10% of hours paid to the assembly workers is for idle time.

Production overheads – recent historic cost analysis has revealed the following production data:

Total production overhead Total assembly labour hours
($)

Month 1 620,000 19,000

Month 2 700,000 23,000

Question: Calculate overheads per radio

Answer: High – Low Method

Variable cost/unit = (High Cost – Low Cost) / (High Level of Activity – Low Level of Activity)

= ($700000 – $620000) / (23000 labour hours – 19000 labour hours)

Variable cost = $20 / labour hour

Variable overhead = (30 mins / 60 mins x $20/hour) = $10

My Query with the Fixed costs calculation:

Fixed costs = Total cost – (Variable cost /unit – Number of units)

[Choose Low Level of Activity:= 19000 Labour Hours]

Fixed production overhead = $620000 – ($20/hour x 19000 labour hours)

= $240000

Here is my exact Query:

Fixed costs are $240000/20000 hours = $12 per hour

My query is how does one get the 20000 hours for the denominator just above?

I’ll finish off the answer below:

Fixed costs = (30mins/60mins x $12 per hour) = $6.00

Therefore Overhead cost per radio = Variable element + Fixed element

= $10 + $6 = $16 (This is the Answer)

Thank you.