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Hello Sir.
I had a doubt regarding Relevant Cost of Labour (I do understand that this same question has been asked by students in past on the portal and i even understood the logic as to why we are adding back Labour Cost to Contribution).
However sir in this particular question.
Suppose that another special job will require 20 hours of skilled labour. The skilled workforce is paid $15 per hour and is working at full capacity.If the special job is undertaken, the skilled labour would be taken
off other work that earns a contribution of $12 per hour, after deducting the costs of the labour and variable overheads of $1.5 per hour.In this situation the relevant cost of labour must include the variable cost of the labour (20* 15) plus any associated variable overhead (20*1.5) and the contribution that would be lost by taking the skilled workers off the other work (20*12).
I understood why we took loss of contribution as well as labour cost (from your reply to students in past) but why are we adding Variable Overhead as well ?
Shouldn’t it just be Contribution+ Labour CostIt is because the variable overheads are incurred on an hourly basis in exactly the same way as the labour cost itself is incurred. Therefore they are treated in the same way as the labour cost for the same reasons.
Sorry Sir, but i couldn’t understood it.
What i thought was if the labour would be taken off the existing work, then there would not be any work on existing job/work.
Therefore the Variable O.Head Cost would be saved just like in case we had material cost (which you have explained in your past replies to students).
Because at 0 activitiy level variable costs are 0And other thing that i thought as to why the Variable Overhead was included was that maybe the variable Overhead cost comprises of indirect labour cost which is variable in nature (which i personally don’t think is valid.
Can you please help me out sir. I’ll be reply thankful, i have spent a lot of time trying to find an answer but unable to find any.
It is exactly the same as for labour (because the overheads are on an hourly basis).
So if labour is taken from other work to do a special job, they will still be paying the labour and they will still be incurring the variable overheads.
They will lose the revenue from the existing work but they will save on the materials for the existing work. So the net amount lost (and therefore the relevant cost) is the revenue less the materials saved. This is automatically always equal to the contribution plus the labour plus the variable overheads.
Sir do you mean to say that since, Variable O.Head are absorbed on Labour Hours, and as labour is taken from other work to do a special job, they will still be operating and they will still be incurring the variable overheads.
In case that’s the point, shouldn’t the other work and the special job have different variable Overhead rates as both the works are different. They might incur indirect variable cost of completely different figures.
That is exactly what I replied before.
The rate per hour won’t be different. The total will obviously be different if there are different number of hours.
Sir i think i understood what you have explained.
But sir is this rule of also adding the Variable Overhead Cost to Contribution and Labour Cost only applies when Variable Overhead has been expressed in per hour terms?
Because Sir there’s this question in the Exam Kit of B.P.P which goes by the name of Ennerdale, I’m just writing a small extract of it
The contract requires 800 hours of skilled labour. Skilled labour is paid $9.50 per hour. There is a
shortage of skilled labour and all the available skilled labour is fully employed in the company in the manufacture of product P.The following information relates to product P:
1. Selling Price (unit) – $100
2. Skilled Labour (unit) – $ 38
3) Other Variable Cost (unit) – $22.Q. What is the relevant Cost of skilled labour with should be included in the contact.
The answer has been given as $15600.
Sir here we have not added the the Variable Overhead Cost when deciding the Opportunity Cost.
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