STEP COSTS, RELEVANT RANGE Bellati Inc. produces large industrial machinery. Bellati has a machining department and a group of direct laborers called machinists. Each machinist is paid $50,000 and can machine up to 500 units per year. Bellati also hires supervisors to develop machine specification plans and to oversee production within the machining department. Given the planning and supervisory work, a supervisor can oversee, at most, three machinists. Bellati’s accounting and production history shows the following relationships between number of units produced and the costs of materials handling and supervision (measured on an annual basis):

Units Produced Direct Labor ($) Supervision ($)

0–500 36,000 40,000 501–1,000 72,000 40,000 1,001–1,500 108,000 40,000 1,501–2,000 144,000 80,000 2,001–2,500 180,000 80,000 2,501–3,000 216,000 80,000 3,001–3,500 252,000 120,000 3,501–4,000 288,000 120,000 Required:

. Prepare a graph that illustrates the relationship between direct labor cost and number of units produced in the machining department. (Let cost be the vertical axis and number of units produced the horizontal axis.) Would you classify this cost as a strictly variable cost, a fixed cost, or a step cost?

. Prepare a graph that illustrates the relationship between the cost of supervision and the number of units produced. (Let cost be the vertical axis and number of units produced the horizontal axis.) Would you classify this cost as a strictly variable cost, a fixed cost, or a step cost?

. Suppose that the normal range of activity is between 1,400 and 1,500 units and that the exact number of machinists are currently hired to support this level of activity. Further suppose that production for the next year is expected to increase by an additional 500 units. By how much will the cost of direct labor increase? Cost of supervision?

Exercise