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PM Chapter 9 Questions Short-term decision making

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  2. Respected sir ,
    I have issue with ques no. 2
    it says 1500kg material Originally cost $8 but answer shown in ques takes 2000 kg material with current cost of $10 which includes 1500 kgs as well.
    Is this because $8 is sunk cost ?
    If it is a sunk cost then why we are considering 1500kgs ?

    • The material is in regular use and so the 1,500 kgs need replacing and will cost the current purchase price. The $8 is a sunk cost and is irrelevant.

      Did you watch my free lectures on relevant costing before attempting the test?

  4. Hi there,
    I just want to understand the difference between question 2&4 and the difference between question 3&5. Somebody to please help me spot the difference?

    • In question 2 the material in inventory is in regular use, but in question 4 there is no other use for it.

      In question 3 there is a substantial amount of idle time. In question 5 there is no idle time and they will have to be taken off other work.

      Did you watch my free lectures on relevant costing before attempting the test?

    • We certainly will be paying the $8 anyway.

      However, let me make up some figures so as to explain 馃檪

      Suppose the revenue per unit is $30, the materials are $10, and the labour is $8. So the contribution is $12.

      If the labour is used on another contract, then we lose the revenue of $30, we save the materials of $10. We still pay the $12 and so the net loss is 30 – 10 = $20. This is always going to be the same as the contribution (12) plus the labour (8).

  7. In Q3 there is a enough idle time thatsy there will be no loss of contribution but we are using 5000 labour hour for special contract so we have to pay them $8 per hour. So I think it will be $40000 relevant cost because labour cost is variable in nature.

  8. Hello sir,
    Hope you are doing well.
    Sir i have a doubt in q5. Why we add regular labour cost . contribution=selling price- variable overhead. And labour cost is deducted in contribution and toeliminate the effect of deduction which is already paid we add labour cost . Is this the reason why add labour cost.

    • You are correct 馃檪
      It is the same logic as that I use in my lecture example for machine electricity,
      (If you are still at all unsure, look in the Ask the Tutor Forum – I have made up little examples to convince people who have asked 馃檪 )

      • I think the answer to this question is $60,000 = 5000 x $12
        The $8 is a sunk cost
        it does not change as a result of taking the contract
        The only change is the loss of contribution of $12 per hour

  9. Hi John,

    In the solution of question 4 you state that for the calculation of the relevant cost as part of the inventory we need to multiple 1,500kg with $9 per kg which is the price the material could be sold. My query is why don’t we use the inventory originally of $8 per kg instead of $9?

    Thank you,
    Theo

    • The original cost is always irrelevant because it is a sunk cost.

      $9 is relevant. It is the opportunity cost because if the material was not used in the contract it would be sold for $9. By using it in the contract they are losing $9 that they would otherwise have received.

      I do suggest that you watch my free lectures on relevant costing.

  11. Hi Sir,

    Hope you are doing well. This is with regard to Q. 3 and 5

    Q. 3 How could the relevant costing be nil. I understand that there is a substantial amount of idle time since there is no additional cost involved but why don’t we include the lost contribution ?

    Q. 5 Here we include the lost contribution which is okay but why are we including the wage cost because though we accept the contract or not, we should still pay the labours anyway ?

    Hope you could understand my question

    Kind regards,
    Firnas

    • Q3: There is no lost contribution. There is plenty of idle time and so they can continue to do the current work as well and still earn the current contribution.

      Q5: The do still pay the labour. So they lose the revenue from the existing work but save the other variable costs of the existing work (excluding labour). The revenue less the other variable costs is equal to the contribution plus the labour.

      I do suggest you watch my free lectures before attempting the tests because I explain both of these points in the lecture (and both are common exam questions).

      • Dear John,

        Based on the explanation, I believe we are assuming that labour cost is a variable cost in this question. However, I thought labour cost is typically considered a “fixed cost” in the short run for a business.

        Do you suggest that by tellying us “the hourly wage” in the exam already suggests that the employees are paid by the amount of hours they work? Because in many cases in reality, companies still quote the hourly wage, but the monthly wage’s actually fixed no matter you are idle or not.

        Best,

        Max

      • But we always assume direct labour to be a variable cost throughout Paper F2 and Paper F5 (except obviously in throughput accounting questions, but that is an exception)!!

  12. Hi John,
    In question nr. 5 “taking them away from their other work” means losing contribution (based on the correct answer). I met a few examples where this does not necessarily mean that we lose the job only delaying the completion. Any hints on how the best I can identify the case from the wording? Thanks, Robert.

  16. Hi John

    In example 1 in the lecture we did not use the direct wages as a relevant cost – it was said that this was being paid already so regardless of what the workers were doing it was being paid. Surely this same scenario applies in the test? The company was already paying their wages to work on one project so why do we have to count it as a new relevant cost now? Is it because we are paying it and we are losing the contribution for the other project? But then surely you are gaining contribution on this new project? It just doesn’t tie in with how it was explained in the lecture. Even in example 1 the supervisor’s salary wasn’t counted as a relevant cost as he would be paid anyway. Is this not the same? You were paying to work on project 1 now they are moving to project 2. I seem to be missing something big here.

    Your lectures are amazing by the way – you explain things really well!

    Debbie

    • I do actually explain this in the lecture, but here is a very little example which may convince you.
      Suppose another job has selling price of 100, materials of 20 and about of 30 – so a contribution of 50.
      If we use the labour somewhere else instead, we lose the revenue of 100, we save the materials of 20, but we will still be paying the labour so no saving there. The net amount we will lose by taking the labour to another job will be 100 – 20 = 80.
      Which is the same as the contribution of 50 plus the labour taken of 30. 馃檪

    • They will be paying the labour whatever happens and therefore will lose the revenue from the other product and will save the other variable costs from the other product (but not the labour). The revenue less the other variable costs, is the same as the labour plus the contribution.

      For a full explanation you need to watch the free lecture – I obviously cannot type out the whole lecture here 馃檪

      • Hello Sir,

        I have watched your lecture and I cannot understand why we should consider the $40000 paid to labour as an additional cost, because whether we take the contract or not, we would still have to pay that $40000 to the existing labour.

        Could you please explain why it is an additional cost there?

        Regards
        Aminath

      • I did explain in my previous answer (above!!).

        Let me give you an example:

        Suppose the existing product has a selling price of 100, labour of 20, and other variable costs (materials etc) of 50. So a contribution of 30.
        Suppose the labour is moved to some new work and so we lose the existing product. As a result we lose the sales revenue of 100. We save the materials etc, of 50. (We don’t save labour because they will still be paid.
        So the loss is 100 – 50 = 50 and this is the relevant cost. That is exactly the same (and always will be) as the contribution plus the labour (30 + 20 = 50).

  18. A company needs 5,000 hours of labour for a contract they have been asked to quote for.
    The work currently being carried out by our employees is generating a contribution of $12 per hour, although there is currently a substantial amount of idle time.
    Our workers are paid at the rate of $8 per hour.
    What is the relevant cost of the labour required for the contract?

    Should this be 60K.
    Lost contribution per hour * the number of hours needed (5000) for the project?
    So $12*5000 hours?

  19. Dear John,
    please help me to expalin for second question.

    I understand this question and answer .because of the labour hour is idle time,there is no need to charge for labour chargres for contract.

    (1) A company needs 5,000 hours of labour for a contract they have been asked to quote for.
    The work currently being carried out by our employees is generating a contribution of $12 per hour, although there is currently a substantial amount of idle time.
    Our workers are paid at the rate of $8 per hour.
    What is the relevant cost of the labour required for the contract?

    But I don’t understand this answer for the following question.
    (2 ) A company needs 2,000 kg of material for a contract it has been asked to quote for. They currently have 1,500 kg in inventory, and the material has no other use.
    The inventory originally cost $8 per kg., the current cost is $10 per kg., and the material could be sold for $9 per kg..
    What is the relevant cost for the material required for the contract?

    1500kg of inventory is no other use, so the relevant cost should calculated for 500kg x $10 only and
    I feel confusing whether Lost contribution(1500kg x ($9-$8) should include or not also.

    • You do need to watch our free lectures on this because it is all covered in the lectures.

      For question (2), 500kg are not in inventory and therefore need to be purchased, so 500 x $10 = $5,000
      Because the 1500 kg have no other use and work therefore otherwise be sold for $9, the relevant cost is the lost income of 1,500 x $9 = $13,500 (an opportunity cost).
      So the total relevant cost is therefore $18,500.

      (The $8 per kg originally paid is not relevant – it has already been paid whatever happens (and is a sunk cost).)

      Again, I really do suggest that you watch our lectures.

    • The software at the moment does not allow us to show the workings – only what the correct answer is.

      If you do not get the correct answer and are not clear why (assuming that you have watched the lectures first), then copy and paste the question in the Ask the Tutor Forum and I will explain.

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