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Hi John,
I’ve come across part of a question in the BPP Study Text which has me confused. It’s a relevant costing question which states the following: “The contract requires 800 hours of skilled labour. Skilled labour is paid $9.50 per hour. There is a shortage of skilled labour and the available skilled labour is fully employed in the company in the manufacture of product P.” P’s cost card shows a cost of $38 per unit and a total contribution of $40 per unit.
The solution calculates an opportunity cost of skilled labour as $8,000, which I am comfortable with as the contribution foregone in employing the labour for the special contract as opposed to in the manufacture of P; however, the actual cost of the skilled labour is also added as a relevant cost = 800 hours x $9.50 = $7,600.
My initial logic suggests that, whether or not this special contract is undertaken, the 800 hours of skilled labour would still be employed – you’re simply paying the same people for the same time they would have worked on producing product P, but have “pinched” them to work on the special contract instead – so, it’s not an incremental cost?
Please help me understand their logic for including the actual cost ($7,600) as relevant?
Thank you!
You really need to watch the free lectures on relevant costing, because I do explain this point. (Our free lectures are a complete course for Paper F5 and cover everything needed to be able to pass the exam well).
I will explain with a little example. Suppose labour is currently employed making a product that has sales price of $20, materials cost of $8 and labour cost of $5. So a contribution of $7.
Suppose now that the labour is taken for other work. We lose the $20 revenue, but we not longer need the materials so we save $8. Labour is still paid. So the net amount lose is 20 – 8 = 12. Which is the same as contribution (7) plus labour (5).If ever labour is in short supply and taken from other work, then the cost is labour plus lost contribution.
Sir, if the skilled labour in the above question is paid on a salary basis rather than a pay rate per hour, what changes will it have in the calculations for the following situations:
a) If skilled labour is fully employed in production of P and doing the contract means shifting the skilled labour from production of P?
b) If skilled labour has spare capacityMy answer:
a) relevant cost for contract = just the lost contribution (as skilled labour is paid an annual salary)
b)relevant cost for contract = there is no lost contribution as skilled labour has spare capacity, so the relevant cost will only include material cost.Your answer to (b) is correct, but your answer to (a) is not.
Read the reply I gave to Mishern above!
Sir, thanks for your reply. Does the skilled labour being paid on an annual salary basis or a per hour rate have effect on the calculation of relevant costs?
Also, how is the lost contribution $8000?
The original question was not typed out in full. The lost contribution depends on how many about hours were used per unit. Since I don’t have the whole question I cannot check the 8,000, but Mishern was happy about the 8,000 and was not asking about that bit.
For this question it would make no difference as to whether the labour was an annual salary or was being paid per hour.
But john sir in a past paper (dec 2011) a question “The telephone co” was structured same as samit..two engeeneers were being paid already an annual salary ..and these engeeneers were busy and these were diverted from the existing contract to special one..and there we are not considering the salary as relevant cost since that salary is the amount which is not being sacrificed for the special contract..
But have you read the answer properly? We would have taken their salary plus the lost contribution had it not been for the fact that it was cheaper not to take them away from their existing work – it was cheaper to let them continue with their existing work and do the new work later so that the only cost involved would be the 500 penalty.
Again, I do suggest that you watch the free lectures on relevant costing.
Thanks for ur kind reply….Sir plz review your answer once for any typing mistake because i could not undrstand it completely..
There is no typing mistake in my answer 🙂
They are not taking the workers away from their existing work.
Instead they will do the work later when the workers have spare time and the only cost will be the penalty of $500.Point #1Yeah..got this point now that contribution woild not be forgone..jst would be delayed by choosing new contract?.. am i right now for point 1?
Point#2 but why cost of two engeeneers is not considered relevant for new contract? Because there was a commitment to pay them 4000 each even they are free..so it means this is the amount which will not be specially sacrificed for new contract..am i right for point 2?
The two engineers are being paid whatever they end up doing (even if they end up doing nothing), so there is no extra cost involved in terms of their salaries.
The only extra cost there will be is the penalty for doing the work later.
Point #1Yeah..got this point now that contribution woild not be forgone..jst would be delayed by choosing new contract?.. am i right now for point 1?
Point#2 but why cost of two engeeneers is not considered relevant for new contract? Because there was a commitment to pay them 4000 each even they are free..so it means this is the amount which will not be specially sacrificed for new contract..am i right for point 2?
Sorry..by mistake it was forwarded you again..
Well john sir..it means i m right for point 2 also?
hi john…..
I’ve come across part of a difficult question which confused me alot. It’s a relevant costing question which states the following:
The labour requirement for a special contract is 250 skilled labour hours ( paid $10 per hour ) and 750 semi skilled labour hours ( paid $8 per hour ).
At present skilled labour is in short supply, and all such labour used on this contract will be at the expense of other work which generates $12 contribution per hour (after charging labour costs).There is currently a surplus of 1200 semi skilled labour hours, but the company currently has a policy of no redundancies.
The relevant cost of labour for the special contract is :
A) $3000
B) $ 5500
C) $8500
D)$ 9000Please help me to solve this question!!!!
You must have an answer in the same book in which you found the question, and so ask about whatever it is in the answer that you are not clear about and then I will explain.
(I assume that you have read all the previous posts in this thread?)
actually john sir ,seriously i am finding difficult to get the answer……………and this question was there in my practice tutes..so there no answer to be found in the book..
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