Milano Company has an average overhead cost per hour of $10.50 at 3,500 machine hours, and at 3,000 hours it is $11.25. The company managers wish to estimate the overhead cost function.

1/. What is the variable overhead cost per machine hour?

a. $1.00

b. $2.00

c. $6.00

d. $8.00

2/ What is fixed overhead cost?

a. $15,750

b. 36,750

c. 21,000

d. 18,000

e. None

Overhead cost is the total of all indirect costs. Indirect costs are those which are not specifically for a particular product. They include indirect material cost, indirect labour cost and indirect expenses.

Variable overhead cost is the portion of the total overhead cost which changes with activity level changes. For example, when more machine hours are worked, more kilowatts of power would be consumed and therefore increase the power cost.

Fixed overhead costs are those which remain on change within a given level of activity.

To separate the fixed overhead from the variable, we use the following relationships below:

VOH/hr = Total overhead@ high activity- Total Overhead @low activity

High activity - Low activity

Fixed Overhead = Total overhead @ high act. - (VOH/hr × High activity)

Note that activity level level is measured in machine hours in this question.

Total overhead = Average cost per hour × Number of hours

Now we can determine the variable overheads per machine hour (VOH/hr)

VOH/hr = (3500× $10.50) - (3,000× $11.25)

3,500 - 3,000 machine hours

= $ (36,750 - 33750)

500 hrs

= $6 per hour

Fixed overhead cost = ( 3500 ×10.50) - ($6 × 3500)

=$ 15,750