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Hi This might be an F2 question- but I found it in a F5 book.
The principal budget factor for Product Z is material A. The company warehouse holds the total supply of material A required for the next month’s planned production of Product Z and no further supplies will be available. No inventory of Product Z is carried.
A flood in one corner of the warehouse has destroyed 64 kg of material A.
The standard cost card from Product Z is as follows:
$
Selling price 235
Material A (8 kg @ $6 per kg) 48
Labour (6 hours @ $9 per hour) 54
Variable overhead (6 hours @ $7 per hour) 42
Fixed overhead (6 hours @ $5 per hour) 30
What is the cost to the company as a result of the flood’s destruction of material A?
If 64kgs of Material A has been lost, then we have lost 64kg/8kg = 8units?
So loss in contribution- sales-vc
Sales=$235*8 units=1880
VC=8 units(48+54+42)=1152
Contribution= 1880-1152
=28
The answer is 1,112. The soultion did not include material in the VC calculation. But why? Material is also a VC and contributes to calculating contribution right? why has the answer only factored in labour and Variable overhead?
Thanks
The material have already been purchased and the money spent – so this is a sunk cost and is not relevant.
What is relevant is that if they are unable to produce X then they lose the revenue of $235 per unit, but they will save by not having to pay the labour of $54 per unit and by not having to pay the variable overheads of $42 per unit. So the net loss is 235 – 54 – 42 = 139 per unit.
They will lose production of 8 units (64kg/8kg) and so the total relevant cost = 8 x 139 = 1,112