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we have labour that is currently being used inmanufacturing process A.
The following figures are available for manufacturingprocess A:
$ per/unit
Sales revenue 25
Materials 10
Labour (2 hours @ $3 per hour) 6
Variable overhead 2
Contribution 7Labour is now required for manufacturing process B within the same organisation.
Each unit within manufacturing process B uses two hours of labour.
No more labour can be hired and so it would have to be moved
from manufacturing process A.
What is the relevant cash flow for labour in process B?Answer given $13 (relevant cost)
the net cost of moving the labour to process B
is ($25 – $10 – $2) = $13 per unit.My first question is opportunity cost is the loss of other alternatives when one alternative is chosen.So does it mean the total sales revenue forgone i.e; $25 is the opportunity cost or (revenue – expenses) will be opportunity cost.
and why the labour expenses haven’t been deducted from that i,e; $6
similarly another example,
if a man have $100 to invest and he has 2 investment option
1st investment option will give him return of $120
while the 2nd option will give return of $140if the man choose the 2nd option what will be the oppotunity cost?
will it be 120$
or $20 as ($100 is the principle amount invested)The questions you are asking used to be asked a lot in Paper F2, but very little (and less complicated) these days, because it is now primarily a Paper F5 topic.
Certainly your question about the labour is very much Paper F5 – if you are interested in the answer then you need to watch the Paper F5 lectures on relevant costing. The labour will be paid anyway whatever the workers are working on.
Opportunity costs are not relevant in something like your second question. The only relevance of opportunity costs is when making decisions and the decision in your second question is perfectly obvious without worrying about opportunity costs!!
Opportunity costs would only arise if making the investment was losing income that is currently being received, which is not the case in this question.okay
one thing sir can u plz clarify me the exact meaning of opportunity costis it the profit forgone from next best alternative or
it is the best among all the alternatives………..and if the best one chosen then there is no opportunity cost. as the example given. The man choose the option of getting return of $140, which was best among the 2 option.
and another question does relevant cost also consider the future cash inflow which may have been earned if a alternative is chosen or it only refers to the future incremental cash outflow and not cash inflows.
An opportunity cost is income that could have been earned, but will not be earned as a result of making a decision.
Relevant flows are all future incremental cash flow effects on a business – whether they are inflows or outflows.
ok im clear now about the relevant flows
but still the thing u have said about opportunity cost bring some question to my mind.
that is
if a decision is taken to choose an alternative where the return is highest than other alternatives in that case will there be any opportunity cost,or opportunity cost only happens when other alternatives are present which gives highest return that the alternative chosen.You are making life far to complicated for yourself (and for the exam).
As far as the exam is concerned (for all exams – not just F2), the only relevance of an opportunity cost is if you are considering a project and doing it will result in losing income that you are currently receiving, then the lost income is an opportunity cost of doing the new project.
If you are comparing two projects then you will assess each project separately and then choose whichever is best of the two (and not bother about opportunity costs of doing one of them as opposed to the other one).
yeah sir, i was really complicating the things. Thanks for pointing me out.
okay so opportunity cost only comes into play when we are already doing a particular project and if we are thinking about taking up a new project in place of the one we are already engaged in, and if that new project gives less return than what we are already earning now, then the amount of less return will be the opportunity cost of taking up the new project.
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