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Hi John
I need some help with this:
We need 250hrs to produce special product.
Option 1: weekend overtime- too expensive
Option 2 – the answer: we can divert staff from producing product qz but we will loose sales , contribution per unit £12, take to make 3hrs, The normal labor rate is £9 per hr. The relevant cost is the direct labour cost + the opportunity cost – this is at (£9 per hr + the opportunity cost £12:3 =£3250
Why doesn’t it include the direct labour cost? We’ve got the staff already and we’ve paid them to make product qz anyway. I thought the relevant cost is just lost contribution.
Thanks
OksanaNo. When labour is in short supply then the relevant cost is the lost contribution plus the labour cost.
Here is a tiny explain to explain why. Suppose they are currently making a product that takes one hour of labour, and had a selling price of $100, a labour cost of $20, and a material cost of $60 – so the contribution is $40.
Suppose that 1 hour is taken for another job. As a result we lose the sales of $100, we save the materials of $10, but we will still be paying the labour of $20 so no saving there.
As a result the net loss is 100 – 40 = $60, which is always the same as the contribution plus the labour (i.e. 40 + 20 = $60).I do explain this in my free lectures on relevant costing and I do suggest that you watch them.
The lectures are a complete free course for Paper F5 and cover everything needed to be able to pass the exam well.
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