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Hi john sir..kindly help me with the following..consider the following situation..
A contract is under consideration Contract requires 2 skilled workers time as follow.
Skilled worker A: 8 hours
Skilled worker B: 5 hoursThere was already a commitment to pay both of the workers $1000/day to each regardless of the fact that they are working or not. Standard time/day is 8 hours for each worker.
Worker A has spare capacity for 8 hours exactly but worker B is fully busy on some existing contract which is earning a contribution of $5/hour which will be lost if new contract is undertaken.
Required: calculate relevant cost of the contract under consideration.
Sir i did it this way considering some factors..please advise me where i am going in wrong direction. I have wached free lectures but this point is now confusing me.
Worker A: Since his wages/day will be paid regardless of whether he works on the new contract or not. So company will sacrify nothing specially for the new contract. So relevant cost will be “0” in this regard.
Moreover there will be no opportunity cost (contribution forgone) as worker A was not busy on existing contract. So nothing was lost in this regard by working on the new contract.(Am i right sir for worker A)
Worker B: Since his wages/day will also be paid regardless of the fact whether he works on the new contract or not. So company will sacrify nothing specially for the new contract. So relevant cost will b “0” in this regard.
However, there will be opportunity cost (contribution forgone) as worker B was busy on existing contract which was earning $5/hour. So $25 ($5* 5 hours) will be lost due to new contract.
So the only relevant cost for worker B will be 25.John sir plz also read out my concepts which i written above and guide me where i’m wrong. I’ll be very grateful.
You are correct for worker A, but not for worker B.
If labour is taken from other work, then the relevant cost is the labour rate plus the lost contribution.
I do explain this rule in the lecture, but let me explain it again with a very simple examples.
Suppose the other product has revenue of $50, labour cost of $10 and materials cost of $25. Then the contribution from this product is $15.
Suppose now that the labour is taken from this product for our contract. We will still be paying the $10 labour. However we will lose the revenue from the other product of $50, but we will save the materials on the other product of $25. Therefore the net amount lost by taking the labour is $25 (50 – 25) and this is the relevant cost. This $35 is the same as the labour cost of 10 plus the lost contribution of 15, and always will be the same.I complety agree with u and i completly understand ur example. But ur example gives me a sense that $10/hour is an incremnetal cost as this is amount which will be sacrificed for the contract under consideration. If we do not undertake the contract under consideration then this $10/hour would be avoided. Even if the existing contract is not continued this $10/hour would be avoided. So this one is totally dependent on a manager’s decision. I have read a similair example in another thread. But my question/point of concern is still there and it is different scenerio..
$1000/day is being paid whatever they end up doing (Even if they end up doing nothing) there is no extra cost involved in terms of per day wages. So there is no incremental cost in this regard.Even there is no contract then still it would have to pay. Bt in your example the case is different.
Thanks for your patience and reply!
Moreover in another thread..you have explained me that why two enjeeneers salaries are not included in the cost as relevant..your statment ( The two engeeners are being paid whatever they end up doing (even if they end up doing nothing) so there is no extra cost in terms of their salries) “The telephone co”
I think i wrote the question above in poor wording which is not so much unxerstandable..
Not at all.
The 10 per hour is not an incremental cost at all. The cost is the lost revenue less the saved material, which will always arithmetically be equal to the labour blues contribution.
The revenue less the other variable costs must be the same as the contribution before subtracting labour.The other question you refer to is completely different because they are not taking about from another job – they are still doing the other job but just delaying the new contract and therefore the only cost is the penalty.
Incremental cost is a cost which incurs as a direct consequece of a manger’s decision..am i right? So your example: $10/hour would not be paid even if the existing contract is not continued..That would be avoided in that case….so if manager decides to go with new contract this must also be charged to nea contract because it is incurred on the new contract..
But when it is being paid already..it would not be avoidable in any case..niether for existing contract nor for new one..then how can we charge this to the new contract..It is committed not the future cost..John sir plz dont mind..this is first time that i m stuck on a point..
One more thing..in this particular question how will u calculate the cost of new contract exactly..
The word incremental means extra, and so yes – it is the extra cost to the company of doing the work, including opportunity costs.
You have not read my previous reply properly. In my example, it is the revenue less the other variable costs that are being charged to the contract – not the labour. Look at the figures again in my little example – it is simply the lost revenue and the saved materials that are being charged to the contract. This is always equal to the contribution plus the labour – it has to be equal to that. Taking contribution plus labour is the easiest (and often the only way because of not enough other information) of arriving at the net of the lost revenue and saved other variable costs.
In your example, the labour cost per hour is 1000/8 = 125. Therefore the cost per hour of moving them from the existing work is 125 + 5 = 130. Therefore the relevant cost for the contract is 5 hours x 130 = 650.
John sir..the calculation u performed i completly agree and understand ..jst my concern is tell me whether $1000 is committed cost or not? It will b paid anyway..if the answer is yes then to charge this cost to new contract would be against the principles of relevant costing..This is the point basicaly which is annoying me a lot.
The $1000 is a committed cost and it is not being charged to the new contract.
What is being charged is the net of the lost revenue and saved other costs of the other work. We are not told what the revenue from the other work is, and we are not told what the other variable costs of the other work are. But the net of the two must be the same as the contribution plus the labour cost.
Sorry for being late due to intrnet problm ..john sir we remained in heavy discusion for some days and i m really thankful to u that u tried ur best to explain me..and its now much clearer..thanks a lot again sir
And i would like to advice other students that look at the thread which i created on relevant costing bt john sir tried his best to explain to make a single point clear..bt if you only write down a question for only a solution then surely it will b irritating..
Again thanks sir..
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