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B Co operates a production process which generates a contribution of $4 per hour. Wages are paid at $7 per hour and labour is fully utilised. During busy periods workers are offered the chance to work overtime, which is paid $10 per hour. However, workers are currently refusing to work overtime which is paid $10 per hour. However, workers are currently refusing to work overtime because of an industrial dispute.
B Co has just received an additional order which must be fulfilled immediately and which will require ten hours of labour to fulfil.
What is the total relevant cost of labour
Relevant cost = Contribution lost + Labour cost
= $4 + $7
= $11 per hour
$11 × 10 hours = $110
why is $7 used here? we were already paying 7 per hour … for overtime we ill be required to pay 10… ? please explain
When finding the relevant cost of labour, the first question we should ask is ‘do we have spare capacity?’ If we do (and our labour is paid a guaranteed minimum number of hours), then we can undertake the job at no extra cost, therefore the relevant cost is zero (remember that relevant costs look at the change in cash flows as a result of a decision).
However, in this question, there is no spare capacity, so we have to look at the options available, and pick the cheapest.
If we pay overtime, or hire extra staff, any extra costs are relevant as the extra costs are directly linked to the job. The other option is to divert production from another product, which is an option here.The overtime cost is $10/hr, so ordinarily we would choose this as it is cheaper, however due to the industrial action no overtime is available.
So it’s $11 * 10
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