F5 Revision Mock Exam

Second question : A contract requires 100 hours of skilled labour. Labour is paid $5 per hour. Labour is currently fully occupied making another which is generating a contribution of $8 per unit. Each unit of the other product requires 2 hours of skilled labour. What is the relevant cost for labour? (Answer is 900 but how?)

First question: If I did say that, then either I got confused or you misunderstood me. Let me explain with a small example! Suppose we produce 100 units of A and 1000 units of B Suppose the total set-up costs are $2,200. Then using traditional absorption they will be absorbed at $2,200/1,100 = $2 per unit. So the total overhead charged for product A is 100 x $2 = $200 Suppose that we use ABC and that each product needs 1 set-up (regardless of how many units are produced). That means it is $2,200 /2 = $1,100 per set-up. So since product A needs set-up then the total overhead for product A is $1,100 Absorption costing will have under-allocated the overhead cost. (It is not automatically the case, but it does tend to under-allocate)

Seceding question: When labour is fully occupied elsewhere, then the relevant cost is: labour cost per hour + lost contribution per hour. (The logic of this is explained in the free lecture on relevant costing). In this question, about is paid $5 per hour. The other product takes 2 hours per unit and gives a contribution of $8 per unit. So the contribution that will be lost by not making it is $8 / 2 = $4 per hour. So the relevant cost of labour is $5 + $4 = $9 per hour. 100 hours are required so the total cost is 100 x $9 = $900

First question : So is statement 1 correct?

Yes - both statements are correct. (I do apologise - what has happened is that the answer in the exam has been corrected, but not yet uploaded. It is my fault and is because I am busy providing pop-up answers to all the questions before re-uploading it, and given there are several 100 questions in the bank it is taking a bit of time :-( )