398,000
Less: labor cost savings (2,000 hours × $41 per hour) .. 82,000
Net increase in annual costs ... $316,000
Even if the entire 6,000-hour reduction in direct labor-hours had hap-
pened, that would have added only $164,000 (4,000 hours × $41 per
hour) in cost savings. The net increase in annual costs would have been
$152,000 and the machine would still be an unattractive proposal. The
entire 6,000-hour reduction may ultimately be realized as workers retire
or quit. However, this is by no means automatic.
There are two morals to this tale. First, predetermined overhead rates
should not be misinterpreted as variable costs. They are not. Second, a
reduction in direct labor requirements does not necessarily lead to a re-
duction in direct labor hours paid . It is often very difficult to actually re-
duce the direct labor force and may be virtually impossible except
through natural attrition in some countries.
Case 3-34 (120 minutes)
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